Here’s Why This Analyst is Cautious on Best Buy Shares
Q1 non-GAAP EPS beat driven primarily by cost savings, but also largely by adding back special items. We expected Q1 non-GAAP EPS of $0.49, excluding $0.15 of net charges, while actual non-GAAP EPS of $0.72 excluded $0.25 of net charges. The earnings beat was primarily due to Q1 SG&A margin contraction of over 100 basis points year-over-year, while SG&A dollars grew 2% including the additional week (down y-o-y on a 13-week basis). The company maintained full year SG&A dollar guidance of up 3% over last year. We note that Q1 revenue of $11.6 billion increased 2.1%, but declined 4.3% on a 13-week basis, while SG&A declined only slightly. In our view sustained expense leverage is unlikely.
A Closer Look: Best Buy Earnings Cheat Sheet>>
International comps were negative for all segments aside from Services. The comps for Consumer Electronics were down 17.7%, Computing and Mobile Phones were down 5.7%, while the comps for Entertainment were down 18.9%, and Appliances were down 26.2%. Declines were driven by a 28% comp decline at Five Star stores in China (as government sponsored programs expired and the economy slowed), declines in Canada due to slow sales of notebooks, home theater and gaming, and declines in Europe due to macroeconomic challenges compounded by changes in network subsidies for pre-pay phones in the UK.
We remain cautious on Best Buy (NYSE:BBY) 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. The next major product upgrade cycle for CE devices is likely at least a few years away, and Best Buy’s stubborn pricing for items that are increasingly viewed as commodities alienates consumers. 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 (NYSE:BBY) 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, but lowering our 12-month price target to $20 from $23. Our revised price target reflects a P/E multiple of 6x our FY:14 EPS estimate of $3.30, well below Best Buy’s (NYSE:BBY) historical 12–15x multiple due to continued comps declines, sluggish revenue growth, and eroding profitability.
Michael Pachter is an analyst at Wedbush Morgan.
Further Reading: Best Buy: We’ll Be Back>>