Is Best Buy All Out Of Confidence?

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

In this note, we consider and ultimately reject the tenants of the bull thesis on Best Buy (NYSE:BBY) shares: [1] brick-and-mortar retail will never go away; [2] specialty retailers such as Best Buy have a great selection of desirable products at competitive prices; [3] consumers prefer to see products (“showrooming”) before purchase; [4] Best Buy has a competitive advantage over Internet retail insofar as it offers customer service and installation; [5] Best Buy can stave off the threat of migration to Internet retailers by offering a competitive Internet retail site of its own; [6] the “discount” on the Internet is not that great (4 percent, according to Best Buy); [7] Best Buy can keep its customers by offering price match; [8] new Best Buy management is deeply experienced in selling on the Internet and selling private label (high margin) merchandise; [9] Best Buy has a ton of opportunity to cut overhead without sacrificing service; [10] Best Buy can maintain its gross profit dollars in the face of discounting by selling more stuff to its existing customers.

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We believe the lack of revenue and earnings guidance adds a layer of uncertainty about the company’s future, especially given the precipitous decline in cash flow. In our view, the lack of guidance reflects the company’s lack of confidence in its core business, and highlights the many difficulties that it faces.

We reiterate our UNDERPERFORM rating and are maintaining our 12-month price target of $9. Our target reflects further operating margin erosion, low visibility, lack of FY:14 guidance, the lack of a credible buyout opportunity, and our doubts about the company’s turnaround plan. Best Buy  has been able to stem sustained comps declines only through price promotion, and we believe that continued price matching will erode margins further.

Best Buy remains at a significant disadvantage to its lower-priced and lower-cost peers, and we believe that price matching will merely cause its competitors to lower prices in response. While we expect comps to stabilize, we think that any new customer wins will come at low margin, and think that the existing customer base will take advantage of price matching to the extent that overall gross profit dollars will actually decline. We expect increasing competition over the holidays from online retailers, in particular from Amazon, and expect these competitors to fight to maintain market share.

We think that Best Buy’s online efforts will fall well short of its goals, and will end up being a costly mistake by a company that can ill afford additional spending without a meaningful return.

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