Best Buy Going To Single Digits; Don't Trust Management Projections

| About: Best Buy (BBY)

Best Buy (NYSE:BBY) reported Q3 earnings this week. The company reported an EPS of 3 cents, which is a 94% decline from a year ago. The company reported a 3.5% decline in revenue. Gross profit margins declined a 160 bps to 24%.

This is nothing surprising, we all know big box retailers are suffering due to a changing shift in the way consumers shop. S&P and Fitch both downgraded Best Buy after it reported earnings.

While the new management team has outlined the key problems the company faces and acknowledges that many are self-inflicted, it will take some time for the CEO and senior management team to full formulate its turnaround strategy and execute it.

- Jayne Ross, S&P analyst

Best Buy saw a decline in same store sales by 4.3%. With a forward P/E of 5, many investors could be tempted to buy the stock, but there is too much uncertainty for the company. New CEO Hubert Joly is trying restructure in the entire company, but founder Richard Schulze has intentions to take the company private.

The future of the company is still unknown, but one thing is for certain, Best Buy will mostly likely get smaller. I do not see the company becoming unprofitable, but earnings are sure to decline significantly. The company lowered free cash flow guidance from $1.25 billion - $1.5 billion to $850 million - $1.05 billion for 2013. This is a more than 30% decrease.

Best Buy's market cap stands at nearly $4 billion. The company's FCF is deteriorating at a rapid pace and there seems to be no sign of the decline slowing down. Management has yet to provide any significant plan for restructuring the company. Based on management guidance, the company's P/FCF is around 4.5. This sounds pretty good except for the fact that the company is not very good at providing guidance.

For the first three quarters of 2012, the company saw negative free cash flow of more than $800 million. Best Buy burned through a significant amount of cash from a year ago. The company reported cash on hand of $309 million, which is a significant decline from the $2 billion it reported a year ago.

A lack of cash flow will also mean that Schulze will find it extremely difficult to line up private equity investors for a buyout. Best Buy's focus to battle "showrooming" will mean that the company will have to lower prices to compete with online retailers. I expect gross margins to continue to decline significantly due to Best Buy's new strategies to match prices of online retailers.

A $4 billion market cap is still fairly high for a company that hasn't been meeting its targets. I do not see management meeting its guidance of $800 million in FCF for 2013. I expect that the market may still be pricing in some sort of management buyout, but as time goes on, it seems like it be very unlikely at this point.

Its very possible that the company will swing into single digits as cash flow continues to decline. Investors should sell as it is very unlikely there will be a rebound in the stock price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.