Credit Suisse (CS) is the most recent sell-side firm to join the growing list of Wall Street analysts to issue - or in this case, reinstate - an outperform/buy/overweight recommendation for the shares of Best Buy (BBY).
The chorus of upgrades began with BB&T's brave but much maligned buy recommendation in late January following better-than-expected December sales data:
- BB&T on January 28 with a $21 price target
- Stifel Nicolaus on February 19, $23 price target
- Barclays on February 19, $20 target
The flood gates then opened following Best Buy's March 1 release of its 4Q2012 results that highlighted not only an increase in domestic same-store sales and higher than expected free cash flow but outlined an effective turnaround strategy of price matching to recapture market share, focus on on-line for multi-channel advantages, cost-cutting initiatives and store closures to improve store ROIC by a promising management team:
- Jefferies on March 6, $24 target
- UBS (UBS) on March 8, $24 target
- Piper Jaffray on March 11, $26 target
- Goldman Sachs (GS) on March 12, $25 target
- RBC Capital on March 15, $27 target
- J.P. Morgan (JPM) on March 18, $29 target
- Credit Suisse on March 20, $30 price target
Year-to-date through March 15, the stock had increased approximately 80%. When most talking heads are calling for a dramatic pullback in Best Buy stock given its recent surge and the prospect of weak 1Q2014 numbers, two additional firms upgraded the stock early this week with even higher target prices to account for the rising share price.
At Credit Suisse's target price of $30, BBY's EPS multiple would be approximately 12x on fiscal 2015 numbers. That is in-line with Wal-Mart (WMT) (12x), Target (TGT) (12x) and lower than Hhgregg (HGG) (14x) and the expanding Conn's (CONN) (17x).
|Ticker||2015 EPS multiple||Price to Sales||EBITDA multiple||Operating margin||Debt to EV|
Source: Yahoo Finance, based on March 20, 2013 prices
Since March 15, what are the sell-side analysts looking at that warrant this renewed sense of optimism in the world's largest CE retailer?
As most of us know, its not enough to simply identify mispriced securities. There's a lot of value traps out there. A mispriced security needs a catalyst to uncover the inherent mispricing.
I believe that BBY has a number of catalysts that - without a general market correction - will continue to increase up to the target prices assigned by the most recent firms to issue upgrades.
Catalyst #1: Company annoucements on executing components of its turnaround strategy.
As part of its turnaround efforts, CEO Joly has announced eliminating $400M in SG&A costs. The first phase of this cost saving initiative saw $150M of annual costs removed. Additionally, after closing 49 big box stores in fiscal 2013, Joly expects another 5-10 large format stores to be closed in fiscal 2014. Any announcements from the company pertaining to further cost cuts and store closures will highlight the effectiveness of the management team to implement its turnaround strategy.
Catalyst #2: Limited margin compression.
Best Buy announced that it will be extending it holiday price-matching initiative year-round. Given the fierce competition from notable rivals such as Amazon (AMZN) and Walmart, it is widely expected that BBY's margins will decrease. Offsetting some of the hit to earnings will be the expected increase in sales volume as a result of price-matching in conjunction with an effective multi-channel distribution model. Moreover, from 4Q2013 results, we saw that gross margins were minimally impacted during the holiday price-matching program, most likely a result of the unilateral pricing policies implemented by leading CE manufacturers that set fixed prices for which both brick and mortar and on-line retailers are allowed to sell their newest, in demand products. Additionally, Best Buy will reduce the in-store space allocated to low margin products such as CDs and DVDs in favor of higher margin categories such as mobile, appliances and accessories. Should sales volumes surge on price-matching initiatives with minimal margin erosion, not only will earnings adjustments be revised higher but the company may be rewarded with multiple expansion.
Catalyst #3: Managing investor expectations.
Despite not providing earnings guidance for fiscal 2014, on the 4Q2013 earnings call, CFO Sharon McCollam noted that 1Q2014 is expected to be "under significant pressure" for various reasons. As mentioned, some skeptics believe that BBY's price will correct given the expectation of an upcoming weak quarter. However, what McCollam's statement has done was to effectively manage the expectations of most market observers.
Notice what has been going on since the upgrades started. Current EPS estimates for 1Q2014 have plummeted to $0.24 from $0.45 thirty days ago. Wall Street is expecting a weak quarter! They have adjusted their EPS estimates accordingly. The same Wall Street firms that make up the consensus estimate, have also upgraded the stock recently. Effectively, the bar has been set so low that it almost guarantees that BBY will "beat consensus expectations". That has positive ramifications for the stock.
Though there may be a chance for additional upside surprises to occur most notably the national implementation of the Marketplace Fairness Act that forces on-line retailers to collect sales tax (currently only 8 states force on-line retailers to collect sales tax on purchases from stores that have no footprint in that state) and the divestiture of some international operations that contributed -6.6% in same-store sales in 4Q2013, I would consider them as low probabilities given that the first one is outside the control of management and the second has not been addressed in the current turnaround strategy.
Like most pundits expecting a pullback, I believe that BBY will give up some of its recent upside, but only in a general market correction. Even so, I expect it to outperform the broader indices under such conditions given the support from all the research firms. However, should no such correction occur through 1Q2014 earnings season, I expect BBY to continue its upward climb given the likelihood of a number of catalysts materializing.
If, like ten Wall Street research firms, you believe that the current management team can effectively implement its turnaround strategy, then at its current 2015 EPS multiple of 10x, BBY remains a solid relative value. On a price to sales ratio of under 0.2 and an EBITDA multiple of under 4x, its even more of a bargain.