DEEP ANALYSIS: Best Buy’s Stock Looks Sketchy

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

We revised our Best Buy (NYSE:BBY) estimates to reflect lower Q2 comps and higher contribution from the purchase of CPW’s profits interest. Our Q2 EPS estimate goes to $0.38 from $0.51, above consensus of $0.32 as we lower our expectation for comps, but pass through some upside from the purchase of Carphone Warehouse’s U.S. profits interest. For FY13, our EPS remains at $3.72 compared to consensus of $3.62, although we smoothed the trajectory of expenses throughout the year. For FY14 we likewise revised the trajectory of expenses throughout the year, but remain at $3.30 compared to consensus of $3.71.

Don’t Miss: Wall Street Brief: McDonald’s Falls SHORT, Rupert Murdoch CONCEDES.

Changes to the customer experience expected to negatively impact profitability. The company revamped its Reward Zone Silver program, providing free expedited shipping, access to popular products and sales events, a free house call from Geek Squad, and a 60-day return and price-match policy. This fall, Best Buy will provide employees with additional training and financial incentives for delivering on customer service and business goals. Although these changes may eventually help sales, we believe that lower prices, increased shipping costs, training expense, and a revamped compensation plan are likely to put further pressure on profitability.

We remain cautious on Best Buy shares. We believe Best Buy store traffic is driven by a declining consumer electronics business, and expect the company’s focus on its growth segments (primarily Computing and Mobile Phones) to yield lower-than-expected results as store traffic continues to slow. Same-store sales and margins are likely to continue their decline, with increased SG&A expected; this is an unhealthy combination.

We think Best Buy’s (NYSE:BBY) long-term financial health requires substantially lower store level overhead.  We believe that Best Buy’s store level economics place it at approximately a 10% price disadvantage to online retailers, and we believe that increasingly sophisticated consumers with mobile Internet access will value lower prices over service, ultimately making Best Buy’s big boxes obsolete.

We are maintaining our NEUTRAL rating and $20 price target. Our price target reflects a P/E multiple of 6x our FY:14 EPS estimate of $3.30, well below Best Buy’s historical 12–15x multiple due to continued comps declines, sluggish revenue growth, and eroding profitability.

Michael Pachter is an analyst at Wedbush Securities.

Don’t Miss: The Week Ahead: Apple, Facebook, and Ford Earnings in Focus.

More from The Cheat Sheet