Shares of Best Buy (BBY) continue their impressive march upwards after adjusted second quarter earnings blew analysts and the wider investment community away.
After a 10% jump, shares have tripled so far this year. While operational improvements are impressive and already seen, the runaway momentum on the stock market is a bit exaggerated in my opinion.
Second Quarter Results
Best Buy generated second quarter revenues for its fiscal 2014 of $9.30 billion, down 0.4% on the year before. Best Buy saw the pace of the decline in same store sales growth slow down to just 0.6%, compared to 3.3% a year earlier.
Net income rose from merely $12 million in the quarter last year to $266 million. Diluted earnings per share came in at $0.77 per share compared to just four cents last year.
Net earnings, excluding the positive impact of a legal settlement and the gain on the sale of Best Buy Europe, totaled $0.32 per share, far ahead of consensus estimates of $0.12 per share.
CEO Hubert Joly commented on the developments during the quarter, "In November at our investor meeting, we talked about the two problems we had to solve: declining comparable store sales and declining operating margins. Since that time, the resolution of these two problems has become our Renew Blue rallying cry and the organization's goals and objectives have been prioritized accordingly. While we are clear there is much more work ahead, we have made measurable progress since we unveiled Renew Blue last year, including near flat comparable store sales, substantive cost take outs, and better-than-expected earnings in the past three consecutive quarters."
Looking Into The Results
Domestic revenues rose by 0.1% to $7.81 billion. Best Buy has seen growth from 57 new mobile stands in its stores which were opened in the third and fourth quarter last year. This initiative offset the 0.4% decline in comparable sales.
Online revenues came in at $477 million, driven by a 10.5% increase in comparable sales on increased traffic and average order values. Factoring in the impact of new game console pre-orders, and growth would have come in at 16%.
Gross profits rose by 230 basis points to 26.5% of total revenues on the back of the LCD settlements. Excluding this, gross profits fell by 50 basis points to 23.7% of total sales on continued price pressure.
Selling, general & administrative expenses fell by 30 basis points to 22.0% of total revenues. Adjusted selling, general and administrative costs fell by 80 basis points to 21.5% of total sales.
As such, operating income totaled 4.4% of total revenues on the back of one-time gains. Adjusted operating income rose by 30 basis points to 2.2% of total revenues.
Given all the initiatives, investments, and related cost savings, and their uncertain impact on earnings, the short term outlook is very mixed.
According to the Renew Blue priorities, Best Buy will continue to reduce prices to bolster the competitiveness. Best Buy will further invest in selling, general and administrative expenses which will hurt short term earnings into the third quarter.
As such, Best Buy did not give a quantitative outlook in both revenues or earnings for the current quarter or the remainder of the year.
Best Buy ended the second quarter with $1.91 billion in cash and equivalents. The company operates with $1.68 billion in short and long term debt, for a net cash position of around $230 million.
Revenues for the first six months of the year came in at $18.68 billion, down 5.2% on the year before. Net earnings rose slightly to $185 million. At this pace full year revenues could come in around $43 billion, while Best Buy should be able to generate a modest full year profit.
Trading around $34 per share, the market values Best Buy at $11.5 billion, or at around 0.25 times annual revenues.
Best Buy currently pays a quarterly dividend of $0.17 per share, for an annual dividend yield of 2.0%.
Some Historical Perspective
Long term investors in Best Buy have seen very poor returns despite the strong performance year to date. The ailing electronics retailer saw its shares steadily fall from levels in their mid-fifties in 2007 to lows of $12 at the end of 2012. The news about a possibly buyout from founder Schulze around the time have been well-documented.
As the restructuring charges started to affect this year, shares have nearly tripled to current levels around $34 per share.
Between the calendar year of 2009 and 2012, Best Buy has seen its revenues fall by 8.5% to $45.1 billion. After reporting a $1.3 billion profit in 2009, the company has reported large losses over the past two years. Finally Best Buy is on track to report profits again this year.
Best Buy continues to make progress under its Renew Blue priorities strategic plan. Key improvements include a 10% increase in comparable online sales, an improved net promotor score, Samsung and Windows boutique stores, and continued cost cuts. So far the company has reduced annual costs at a rate of $390 million compared to the $725 million target.
Best Buy stands to receive a total of $229 million from legal settlements regarding price fixing by manufacture of TFT-LCD panels between 1998 and 2006. Best Buy received $30 million so far during the quarter, and will receive the remainder in the coming two years. The excess cash will come in handy in the coming periods, as Best Buy will step up its initiatives.
By now, Best Buy has made the easy cost cuts, by removing management, cutting jobs, closing stores and selling its stake in the European joint venture with Carphone Warehouse.
Still, the progress has been great given the continued pressure from giants like Wal-Mart (WMT) and Amazon.com (AMZN). At the same time, there is more room for cost cuts, although this will be achieved by focusing on the cost of goods sold.
Adjusted earnings of $0.32 per share, or little over a $100 million, imply much good for Best Buy in a non-holiday quarter. The strong balance sheet, current earnings and changing momentum accompanied with additional investments, bode well for the future. Note that Best Buy only has managed cut costs by half of its annual targets.
The gross margin depression, given the increased price competition, was not too bad, while sales actually came in ahead of estimates. Crucial for Best Buy is to remain on track to generate annual revenues of $50 billion in three year's time. The key is to restore profitability to 2-4% of total revenues, resulting in an earnings capacity of $1-$2 billion per year.
While it is not unthinkable that shares could top $50 per share in case Best Buy could meet these future estimates, the current share price reflects a great deal of optimism, a bit too much to my taste. While the operational improvements have been impressive, the fact that shares have tripled so far this year makes me believe the stock market momentum is ahead of the operational improvements.
I applaud management for fortifying the balance sheet and reporting rapid progress, but the current valuation is a bit high for my taste after runaway momentum.