Shares of Best Buy (NYSE:BBY) have not been the best buy ahead of the so important shopping season.
The electronic retailer warned for a lot of price pressure into the important fourth quarter of the year, triggering a sell-off in its shares after very solid momentum already in 2013.
Despite the discount, I remain cautious. I congratulate management for doing a great job and taking the right steps, yet I remain on the sidelines for now.
Third Quarter Results
Best Buy generated third quarter revenues for its fiscal 2014 of $9.36 billion, down 0.2% on the year before. The fall in revenues stems from store closings, as sales came in just ahead of expectations at $9.30 billion.
The company reported earnings from continuing operations of $43 million compared to a $9 million loss last year. Adjusted earnings came in at $0.13 per share, versus a loss of $0.03 per share last year. GAAP earnings came in at $0.16 per share.
Adjusted earnings at $0.13 per share beat consensus estimates by a penny.
CEO Hubert Joly commented on the third quarter performance, "Our third quarter top-line results make it clear that our focus on delivering our unique customer promises is starting to pay off. It is also clear that our efforts to control costs and to bring greater efficiency to our operations are improving our profitability. While we remain mindful of the fact that we still have a long way to go, we are pleased with the progress of our Renew Blue transformation efforts."
Looking Into The Results
Stagnating revenue trends are the result of a very modest 0.3% increase in comparable store sales. Domestic comparable store sales inched up by 1.7%, while the online operations reported comparable growth rates of 15.1%.
Note that comparable store sales in the international operations continued to fall, decreasing by 6.4%.
The good thing is that the revenue falls came to a standstill. Yet the competitive environment resulted in a 60 basis point squeeze on gross margins, falling to 23.2% of total revenues. Strong cost control resulted in a 150 basis point fall in selling, general and administrative expenses, coming in at 21.9% of total revenues.
As a result, Best Buy reported earnings of $54 million compared to a $10 million loss last year. Income from continuing operations came in at $43 million.
Best Buy ended its third quarter with $2.17 billion in cash and equivalents. Total debt stands at $1.67 billion for a net cash position of around $500 million.
Revenues for the first nine months of the year came in at $28.04 billion, down 3.6% on the year before. Net earnings attributable to shareholders rose by nearly 50% to $239 million.
At this pace annual revenues of $44 billion seem attainable while consensus estimates for earnings stand at $850 million. Given Best Buy's caution into the final quarter, the earnings guidance seems very ambitious.
Trading around $39 per share, the market values Best Buy at some $13.4 billion. This values operating assets at $12.9 billion, the equivalent of 0.3 times annual revenues and 17 times earnings, assuming full year earnings could reach $750 million.
Best Buy currently pays a quarterly dividend of $0.17 per share, for an annual dividend yield of 1.7%.
Some Historical Perspective
The very strong recovery through 2013 has softened the pain for long term shareholders in Best Buy. After trading in a roughly $30-$60 trading range for most of the past decade, shares had fallen to lows of $10 at the start of the year, as bankruptcy fears were increasing.
The hire of CEO Joly who initiated large and fast operational improvements have been the base for a strong and solid recovery.
Between 2009 and 2013, revenues are expected to fall some 10% to $44 billion. While the company was still solidly profitable until 2010, the company reported losses in 2011 and 2012. The company is expected to return to profitability this year.
Best Buy's third quarter earnings report did now show major surprises. Yet it is the warning for the so-important fourth quarter which triggered a sell-off among investors.
Joly and Best Buy will stick to its "matching" policy of online prices which has been made permanent in February of this year. The company will face stiff competition from key rivals including Amazon.com (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT).
The promotional environment will increase in the quarter, but CFO McCollam stresses the importance of sticking to its policy, calling it "table stakes in Best Buy's transformation." Any increase in competition will have a greater impact on gross margins.
Gross margins are seen down 80 to 90 basis points on the year before, when gross margins were just 22.6% of total sales. This implies that operating earnings could take a beating of around $100 million for the quarter. Note that selling, general and administrative costs are seen down 10 to 20 basis points.
About a week ago, I last took a look at Best Buy's prospects after analysts at UBS upgraded the retailer to a Buy rating. With shares trading around $44 per share, I thought the upgrade from UBS came a bit late, as I would not jump on the bandwagon.
Despite my hesitance to pick up any shares at those levels, I had to congratulate management after making a huge difference over the past year. Best Buy has made a huge amount of progress in a continued difficult operating environment.
I noted that even if Best Buy could grow to annual revenues of $50 billion going forwards, with earnings peaking at $1.5 billion, the current valuation already seems fair. If Best Buy can achieve such a turnaround it will take the company quite some time.
Despite the 10% sell-off, I reiterate my stance. I applaud management for doing a great job, but the current valuation is too high to initiate a buy position at these levels.