Analyst: Despite Cost-Cutting, Best Buy Can’t Keep Up

Source: Getty Images

Source: Getty Images

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

Best Buy (NYSE:BBY) will report fiscal Q1:15 results before market open on Thursday, May 22, and will host a conference call at 5 a.m  Pacific time (Webcast: http://www.investors.bestbuy.com).

Q1 revenues and earnings are likely to be at or below consensus estimates. We expect revenue of $9.24 billion and EPS of $0.20, vs. consensus for revenue of $9.20 billion and EPS of $0.20. We expect comps to be at or below our estimate of down 1.3 percent (domestic down 1.1 percent, international down 2.8 percent).

Several electronic retailers have cited several headwinds during the quarter driving negative comparable-store sales growth. Aaron Rents and hhgregg both pointed to extreme weather in January, February, and the beginning of March as negatively impacting traffic and operating performance during the quarter. Additionally, hhgregg comparable-store sales results for consumer electronics (down 18.9 percent) and computing and wireless (down 22.6 percent) categories were horrendous, suggesting to us that Best Buy suffered a similar experience.

We expect FY:15 to see continuing comp declines and margin pressure. Last quarter, the company updated guidance regarding the impact of several cost headwinds on operating income for Q1:15 through Q3:15. The impact is expected to be, on average, negative 70 basis points per quarter. We expect comps to remain weak all year, as there is no significant product upgrade cycle this year. We also believe Best Buy will continue to lose high-margin accessory share to online.

Management continues to make solid progress with cost-cutting. Annualized cost reductions last year were $765 million ($570 million in SG&A and $195 million in cost of goods sold). The company expects to capture $1 billion in total savings from the optimization of returns, replacements, and damages (which cost roughly $400 million annually) and logistics and supply chain improvements. We believe these cuts are sustainable, but do not expect cuts meaningfully beyond the targeted amounts. Over time, we think the impact of continuing comp declines and margin pressure from price matching will more than offset cumulative cost cuts.

We are reiterating our UNDERPERFORM rating and twelve-month price target of $18. Our target is based on an EV of 10x sustainable free cash flow, reflecting expected negative comps in FY:15, further margin erosion, low visibility, lack of clear guidance, and doubts about the sustainability of Best Buy’s turnaround plan. We expect comps declines to continue, and we expect price matching to continue to pressure margins. Lower margins could pressure Best Buy’s cash flow multiple.

Michael Pachter is an analyst at Wedbush Securities. 

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