The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Best Buy (NYSE:BBY) Q3 earnings were well below expectations. Revenue was $10.8 billion, vs. our estimate of $11.5 billion, and the consensus estimate of $10.7 billion. Non-GAAP EPS was $0.03 (excluding $0.07/share of restructuring charges), compared with our estimate of $0.14, and the consensus estimate of $0.12.
FY:13 free cash flow guidance is at least $200 million below prior guidance. Best Buy updated guidance for FY:13 free cash flow of $0.85 – 1.05 billion, down from its August guidance of $1.25 – 1.5 billion. We expect the company to continue spending on its comp growth initiatives, although a return to comp growth in the near-term is unlikely. We have modeled comp declines through the end of FY:14, and expect Best Buy to end the fiscal year with free cash flow at the low-end of its guided range, with further declines likely next year as spending continues.
Consolidated operating margin declined 300 basis points in Q3. The factors that negatively impacted gross margin in Q3 are likely to continue over the nearterm, and we expect price competition to intensify over the holidays. As Best Buy’s strategy calls for it to spend on initiatives to drive comps, we expect continued margin erosion, particularly as it matches online pricing through the holidays.
Best Buy’s declining free cash flow makes private equity investment less likely. We calculate that Best Buy generated $2.5 billion in free cash flow in FY:12, and we expect it to generate $850 million in FY:13, the low-end of its guided range. We anticipate free cash flow to fall further as spending increases and margin pressure continues, and have modeled free cash flow of $750 million in FY:14.
We are decreasing our FY:13 estimates for revenue to $49.2 billion from $50.2 billion, and for EPS to $2.50 from $3.06 to reflect Q3 results and revised assumptions for operating margin. We are decreasing our FY:14 estimates for revenue to $47.1 billion from $48.2 billion, and for EPS to $2.20 from $2.90.
We reiterate our UNDERPERFORM rating and are lowering our 12-month price target to $9 from $14.50, which reflects further operating margin erosion, low visibility, lack of FY:13 guidance, our view that a takeover is unlikely, and our doubts about the company’s turnaround plan. We believe Best Buy has been unable to stem sustained comp declines and eroding margins, and remains at a significant disadvantage to its lower-priced and lower-cost peers. Our revised price target reflects a EV/FCF multiple of ≈ 4x our revised FY:14 FCF estimate of $750 million, as we now view free cash flow as a more significant measure of the company’s viability going forward than P/E.
Michael Pachter is an analyst at Wedbush Securities.