This commentary originally appeared on Real Money Pro at 9:10 a.m. ET on Thursday, Nov. 20. Click here to learn about this dynamic market information service for active traders.
Weakness at Best Buy (BBY) following yesterday's release of perfectly fine third-quarter earnings could represent a good buying opportunity.
I haven't yet purchased the stock because I was out most of yesterday afternoon. But while I recognize that selling electronics is a difficult and volatile business, Best Buy is the last national chain standing.
And while BBY has been another poor retail performer over the past year, Wall Street currently values the company at just 4.2x current cash flow even though BBY generates significant amounts of free cash. At the same time, the product cycle for television sets is clearly turning, while BBY has built an online business that can credibly compete with Amazon (AMZN).
Let's do a deeper dive into the reasonably good results that BBY reported yesterday:
- BBY has been quietly exiting some low-margin or money-losing businesses, freeing up cash and management time in the process. The chain reported a 6% overall sales decline, but comparable-store sales rose 0.8%. EBITD also increased by 8.5% and has almost doubled in three years. No one is looking at things on that basis.
- All-important online sales grew 18%, a figure that suggests gains vs. all of retailing (although not necessarily vs. AMZN).
- Reflecting the generation of strong free cash flow, interest costs fell by $5 million, or 23%.
- Pretax profits grew a solid 21% on an as-reported basis. Earnings per share rose 20%, far more than the average U.S. corporate or retail EPS.
- Reflecting confidence in its outlook, BBY has begun quietly buying back its stock, making $385 million of purchases since Jan. 1. Share count has declined 2.8% from its first-quarter peak, dropping by 1.5% in the latest quarter alone. Cash flow also covers interest almost 30 times over, so the company has a good margin of safety.
- Management's fourth-quarter forecast calls for lower sales and EBIT margin pressure, but some of that stems from the fact that the Super Bowl will take place in the next quarter. (The NFL championship game is all-important to the consumer-electronics industry). And having watched this management team since it appeared on the scene a few years ago, I have yet to see a forecast that BBY didn't ultimately exceed.
- The economy and energy prices are big tailwinds, although Best Buy has a significant business in troubled Canada. I also think BBY will benefit from a market-cycle transition currently underway in television sets, as well as from and what could be terminal problems at Sears Holdings (SHLD). That should boost BBY's appliance sales. Best Buy also sells products from Apple (AAPL), which should help results as well.
- Operating leverage is a positive force during the fourth quarter in the retail subsegment that BBY sits in, as margins are high. Above-budget sales can quickly wipe out the margin decline that management is currently predicting.
- Best Buy has more than $1.7 billion in net cash, and that will grow by year's end as the chain sells off its seasonal inventories. (Note: Inventories in no way look excessive to me.)
At 4.2x cash flow, Best Buy represents an excellent value to me, although I've just recently had a chance to digest the earnings report and listen to the conference call.
BBY rallied back from a sharp premarket decline yesterday to close the regular trading day at $30.67, down some 2.1% for the session. At last check, the stock had fallen about 1.5% more so far today.
But after listening to the conference call, I'm encouraged by what company executives had to say:
- While management complained about sequential weakness in category sales representing 65% of the business, what's happening is that consumers are delaying electronics purchases ahead of expected Black Friday deals. Black Friday is basically morphing into "Black November." Executives noted that early November's sales were much better. Management also indicated that it's very comfortable with its prices -- and, therefore, with BBY's profit margins.
- Best Buy has invested heavily into preparing for the transition in the TV segment to 4K, which will be big year-over-year during the fourth quarter. The chain has added hundreds of "shops within shops" for Sony and Samsung. But it appears that management is trying to underplay this very meaningful new product cycle, which could be helpful to BBY's service business due to installation revenues.
- The latest iPhone's release late in the quarter actually hurt results, but that should correct itself in the current quarter.
- Best Buy will continue to see foreign-exchange problems at its formidable Canadian business, as sales when translated into U.S. dollars are falling 30%. The book tax rate will also be an adverse factor. However, there will be mountains of free cash flow at this level of profitability, while the cash returns from stock buybacks are extremely high.
The Bottom Line
I likely would have purchased BBY in yesterday's early morning weakness, but frankly didn't have time to process the quarterly report.
So, I'll wait for another buying opportunity -- as this is a stock that I definitely want to own.