The Day Ahead: Do Your Own Research

 | Mar 27, 2013 | 8:00 AM EDT  | Comments
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I didn't want to give an opinion on a single stock the day after a profound move in the market (and yes, I am still looking for the "new dawn"). But I have to considering the internal range of emotions coming off the set from this segment Tuesday and given I am now part of the financial-media brotherhood.

The chance is high that you at some point you have relied on sell-side research to inform and gain the confidence in pulling the buy trigger. Hell, I used to pump out reports like a stone-cold freak (Stephanie Link got all these reports). Unfortunately, the real deal is that most brokerage-funded research should be completely ignored or analyzed specifically to gauge the mood of the Street prior to earnings reports or important events. This sounds silly but I almost get the sense that many pros and wannabe pros have forgotten what it means to select a stock. Here are a couple of simplistic reminders:

  • A stock's price predicts the future.
  • If a stock is up 37% in four-weeks and you still envision a company doing horribly, might be time to reassess.
  • Big initiatives to improve operational performance could lead to earnings surprises (surprises due to the fact the Street probably remains too negative on the company's prospects).

Below is a short note I released the day of Best Buy's (BBY) earnings, 23 minutes after the numbers hit the wires (obviously listened to the earnings call). Pay careful attention to the bolded items. These little nuances to any company's "story" are important to know and, in this instance, collectively played a role in my upgrade in rating.

March 1, 2013

At first glance, this was another normal quarter from Best Buy, consisting of pressured profit margins and a dreadful international performance. However, upon closer inspection, it's apparent to the trained eye that there are striking positives that jump off the wordy press release. I believe the market's initial positive reaction is correct, and here are some explanations why.

Gross Margin

Adjusted gross margin beat consensus by 32 basis points in spite of Best Buy's new price matching initiatives. As I said in the preliminary note, this was an important thing to get, indicating Best Buy's new team is taking swift action to facilitate better productivity. Moreover, productivity gains are not being swallowed up by investments in price (as is the case at Wal-Mart (WMT)). Best Buy also dropped a statement that investments in 2013 will be more than offset by expense savings, positive.

Online

Best Buy's online business momentum "accelerated" during the quarter. Every transaction online was essentially the equivalent of convincing groups of previously disenchanted customers that, yes, Best Buy is finally price competitive. In other words, Best Buy may finally be on a path to changing price perception (memo: this doesn't happen overnight). As a side note, the company appears to have nicely outperformed its larger box competitors in sales of electronics for the holidays (notably Sears (SHLD)).

Geek Stuff

Free cash flow surprised meaningfully to the upside relative to guidance offered Jan. 11 to the tune of $465 million. I read this as meaning considerable waste is being vacuumed from Best Buy's internal processes, setting the stage for better free cash flow generation amid improved volumes and operating margins. Ultimately, one enters 2013 less concerned that Best Buy will have to extend vendor terms and tap outside financing.

Not a perfect quarter by any stretch of the imagination. For example, the entire international business continues to be an operational eyesore that should be exited once the balance sheet is firmly solidified through stronger U.S. operations. Nonetheless, I don't think Best Buy had to hit a homerun to entice would-be shareholders and prevent what's left of the base from dropping a peace-out sign. All that had to be shown was that the new team, which many on the Street lacked trust in, could drive the company toward the light and not into the retail dustbin alongside Circuit City. From that perspective, the quarter delivered.

In Conclusion

I continue to rate Best Buy's stock, which I had held at a Sell throughout 2012, a Buy. On the market, little cracks in the U.S. recovery thesis continue to be ignored in exchange for a heightened focus on the larger picture. You need to be jotting down cracks in the sidewalk, namely income expectations in consumer confidence (makes it hard to square the jump in credit card/payment stocks) and core durable goods, for they will aid in shaping the future.

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