Here's my take on two new earnings reports from this week.
We'll look at Best Buy Co, Inc., (BBY) first, followed by Papa John's International, Inc. (PZZA) .
Best Buy
I said last week Best Buy really needed to demonstrate an ability to derive earnings without reliance on share buybacks and lower taxes. Well, I'd describe their fourth quarter as halfway there.
On the one hand, comp sales were up and the company succeeded in driving operating income, while also delivering big earnings growth to shareholders. On the other hand, the company still banked on buybacks and lower taxes to create that stellar earnings growth.
I'm a long-term bull on Best Buy. Many of its competitors have gone bankrupt, and I believe there will always be a niche for bricks-and-mortar tech sales. Not everyone is happy with the idea of buying a TV without seeing it first. Not everyone wants to buy a computer they can't test first. Moreover, Best Buy offers a way to get things fixed or consult with a tech expert in person. There are still improvements that need to be made, but I like where they're at.
There was an irony in Best Buy's fourth-quarter results. While domestic comp sales increased 3%, revenue actually declined by 3.5% year over year. The cause was more related to a difference in weeks. The fourth quarter of fiscal year 2018 had one more week than fiscal 2019, as well as the closures of Best Buy Mobile locations, and 12 regular stores.
The big fear for Best Buy going into their earnings was the effect of Apple, Inc.'s (AAPL) phone sales slowdown. While the retailer did note that mobile phone sales slowed somewhat, they had gains in multiple areas, including smart home, gaming, wearables and appliances.
This is what I like about Best Buy. They're in the exact type of retail that is all the rage right now. The day you get me to put any more tech in my place than absolutely necessary is likely the day hell freezes over; but society certainly likes their tech toys. As this stuff grows, I think Best Buy has an edge. I have tested their online experience multiple times, and I believe it to be a competitive offering against names like Amazon (AMZN) .
You can order things online and have them delivered, or you can order online and pick them up at stores. I like this setup a lot because it creates a draw that will get customers into Best Buy stores. Getting consumers into your shop is half the battle. It's worth noting that profit rates dipped by 20 basis points domestically thanks to a periodic profit-sharing benefit. Nonetheless, I like what Best Buy did domestically.
International sales increased 2.5%, while the difference in weeks put a more-costly 5.2% dent in revenue. Gross profit rates increased 50 basis points to 22.9%.
Altogether, gross profit rates were 22.2% vs. 22.3% a year ago. Thanks to lower SG&A expenses, Best Buy successfully drove operating income 12.15% to $978 million. This is what I would like to see more of. I want to see Best Buy create meaningful operating margin improvements from its business.
The fourth quarter still relied heavily on buybacks and tax cuts. Pretax income was $972 million vs. $873 million a year ago, and that increase would have shown an increase in net earnings. But it wouldn't have been nearly as good without share buybacks and lower taxes. Best Buy's effective tax rate was 24.3% vs. 58.2% in fiscal 2018. That had a massive impact on net earnings, which increased roughly 100% to $735 million. Diluted earnings per share increased 118% thanks to the higher net income as well as the 7.8% decrease in diluted shares outstanding.
These big gains will set a tough marker to go against in fiscal 2020, as the tax boost will not create that same growth rate year over year. I also have some concerns over the debt being incurred in these share buybacks.
Long-term debt increased 64.2% to $1.33 billion in fiscal 2019. That's a substantial amount of money that could have been put into innovation and development. While I don't have a problem with share buybacks, they can create a skewed view of the effects of the company's actual net income gains. They certainly bolster investor sentiment as demonstrated today.
As I said, I'm bullish on Best Buy, but there are things to keep an eye on.
Papa John's
Papa John's might have bigger problems on its hands. Control having been largely wrestled away from John Schnatter, it is now a question of whether or not the new management can repair the damage done. This is 100% a PR problem in my eyes.
The drama surrounding the situation that went down with founder John Schnatter clearly struck a nerve with a lot of people. This is going to be a test of whether the company can move on from that and create a new image (and regain the appeal of the former image). That's going to require a lot of time, marketing, blood, sweat, and tears. I'm not sure this is the time to own this name. Their fourth-quarter results included further sales declines. Past that, 2019 guidance suggests a wide estimate for earnings that do not justify the share price. It makes the stock expensive and not necessary for portfolios.
Revenues declined 20% year over year to $375.98 million. For the full year, revenues decreased 11.8% to $1.57 billion. Net income decreased 148% from profits of $28.5 million in Q4 2017 to losses of $13.85 million in Q4 2018. Diluted earnings were equally poor with a loss of $0.44 per share vs. a gain of $0.81 per share in 2017. For the full year, Papa John's squeaked out a net gain of $0.05 per diluted share.
GAAP earnings-per-share guidance for 2019 is $0.00 to $0.50. For the full year, that would mean the stock currently trades at 88x the high-end range for forward earnings. At adjusted earnings (unadjusted earnings face hits related to assistance provided to the North American franchise system) of $1.20 per share, the stock is still trading at 36x forward earnings. It is plain old expensive for a company that hasn't turned things around yet. The pricing doesn't leave much room for a run if sales were to surprise.
Papa John's is a clearer cut case than many stocks today. Sales are bad. There isn't an established path to fixing the issue yet. The stock is very expensive relative to trailing results and forward guidance. On top of everything, the long-term debt cripples their balance sheet, even with the investment from Starboard. I do not consider it an intelligent stock for the typical investor.
If one is holding onto hope that the investment from, and attention of hedge fund Starboard Value, will change things, then maybe you have something to play off of. The fund invested $200 million into Papa John's, and placed their CEO as chairman of PZZA's board.
It's possible that the fund could still find ways to sell off the company. It's also possible the new management environment could create a way to boost growth. Starboard's Jeffrey Smith does have a track record with restaurants. The company improved performance at Olive Garden, and Starboard seems to do well with what it buys.
There's potential. It's just a lot of risk. I wouldn't touch the stock at present.
