Big box retailer Best Buy (BBY) posted solid results for its fiscal year 2013 fourth quarter. Thanks to an extra selling week, revenue was roughly flat year-over-year at $16.7 billion, exceeding consensus estimates. Earnings, adjusted to reflect operating expenses, declined 25% year-over-year to $1.64 per share, which was better than consensus expectations. Overall, sales slipped about 1%, but still totaled $49.6 billion for the year.
The domestic segment is showing signs of life, with domestic same-store sales increasing 0.9% and online growth jumping 11.2% during the quarter. Overall sales fell 0.3% year-over-year as the firm shuttered 49 big box locations. The firm experienced a modest increase in SG&A costs, which were up 140 basis points as a percentage of sales to 16.5% due to a slight increase in advertising spend (which appeared to pay off in terms of driving people into the stores). The firm's gross margin fell 10 basis points year-over-year to 22.4% of sales, negatively impacted by the company's decision to engage in price matching activity. Although we believe this will have a negative impact on profitability over the long haul, we also think it was the move necessary to ensure the long-term survival of the firm.
International revenue actually ticked up 2% year-over-year to $4.2 billion as the firm benefited from favorable currency exchange rate movements. However, the segment still posted an operating loss of $794 million, though it was a significant improvement compared to last year's loss of $1 billion in the fourth quarter. 50 stores were closed in the segment, and it appears some more closures will take place during fiscal year 2014. China and Canada were responsible for the weakness, but the fortunes of both could change going forward.
We're pleased to hear the company speak about allocating more space to higher-margin mobile and appliances segments, replacing the former DVD space that occupied much of the store. We're particularly excited about the potential for increased appliance sales, which only make up about 5% of revenue at this time. Not only do appliances carry higher margins, but we think the segment will benefit greatly from the housing recovery. In fact, the two-year stacked-comp (two years of same-store sales growth combined) for appliances was 26.2% in the fourth quarter.
Though down over 50% compared to the same period a year ago, the firm's adjusted free cash flow still totaled $965 million for fiscal year 2013. Although Best Buy benefited from quicker returns of slow-moving inventory to vendors, it appears to be a long-term change in how Best Buy will operate, yielding higher levels of free cash flow. This has allowed the firm to not only deleverage its balance sheet, but it also provides ample dividend coverage. We were also quite encouraged by what we heard from CEO Hubert Jolly, who mentioned that the company ultimately rejected Richard Schulze's private equity offers in favor of existing shareholders, saying:
"…I wanted to give a quick update on the process with our founder Dick Schulze. So yesterday was of course the deadline for Dick to make a qualified offer and no such offer was received. During the process, Dick introduced to the Company, several impressive private equity sponsors, we all expressed interest in an investment in Best Buy.
"Now the costs of these investments however will determine to be excessive and dilutive to our existing shareholders. Therefore, the Company concluded to not accept these offers. Despite the significant amount of time that management has spent on this process, the organization has remained focused in our Renew Blue transformation and we will continue to do so, as we move forward for the benefit of all of our stakeholders."
We take this statement to be very bullish, as we believe it indicates that management turned down easy returns in favor of the long-term survival of the business.
At this juncture, we're not worried about Best Buy going out of business in the near term. Long-term competitive threats remain very present, but a potential boost from PlayStation 4 this year, solid appliance sales from the housing recovery, and an ever-improving mobile assortment lead us to believe that free cash flow will remain strong in fiscal year 2014. Further, the company posted 5% operating margins in fiscal year 2013 that absolutely dwarfed those seen at "Best Buy Killer" Amazon (AMZN). Best Buy will continue to "right-size," and capital allocation remains crucial. We like Jolly's effort and execution so far, but we believe shares are fairly valued, so we aren't interested in adding them to the portfolio of our Best Ideas Newsletter.