Outlook: Is Best Buy’s Turnaround Plan Sustainable?

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Q4 revenues were lower-than-expected as comps were weak, although adjusted EPS was higher on cost cuts and restructuring. Revenue was $14.5 billion, compared with our estimate of $14.8 billion and the consensus estimate of $14.7 billion. Non-GAAP EPS was $1.24 (excluding a $0.36/share net charge), compared with our estimate of $1.06, and the consensus estimate of $1.01.

Management continues to impress with additional cost-cutting. As of Q4, the company has realized total annualized cost reductions of $765 million. The company increased its domestic Renew Blue cost reduction goals from $725 million to $1 billion that it expects to capture from the optimization of returns, replacements, and damages and logistics and supply chain improvements.

Q4 comps were down 1.2 percent. Mobile was weaker-than-expected, as supply constraints in key mobile phone and tablet PC categories kept growth minimal and contributed to the comps decline. Appliances were the lone bright spot, and will likely continue to be a strong category. Every other category was weak, though we expect entertainment to rebound in 2014. Comp declines are expected for the first half of FY:15, driven by continued weakness in the CE category.

Next-generation video game console sales should provide a lift to overall consumer electronics sales throughout 2014. Both consoles launched in November 2013, and the PS4 and Xbox One have easily outperformed their predecessors through the first three months of release. We expect Best Buy (NYSE:BBY) to capture its normal 15 percent share of console and software sales in 2014.

We are maintaining our FY:15 revenue estimates, but are increasing our EPS estimate to $1.78 from $1.69 to reflect lower gross margins more than offset by SG&A cost reductions of roughly $100 million. As expected, management did not provide detailed Q1:15 or FY:15 revenue or EPS guidance. We expect gross margin to erode 90 bps this year, offset by $350 million in year-over-year cost cuts.

We are reiterating our UNDERPERFORM rating and 12-month price target of $18. Our target is based on an EV of 10x sustainable free cash flow, reflecting expected negative comps in 2014, further margin erosion, low visibility, lack of 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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