Best Buy Co., Inc. (NYSE:BBY) reports its FY 2014 results on Thursday, February 27 before the open. Last month, I wrote an article valuing Best Buy at $49 a share. The three value drivers were increasing sales, a gradual increase in its adjusted pre-tax operating margin to 5.32% and an increase in its sales-to-capital ratio to 3.8. We already know from its holiday sales report that 4th quarter same store sales [SSS] are likely to be down vs. the comparable period last year.
What I will be looking and listening for are confirmation that the company took market share, plans to reduce its Sales, General and Administrative expenses [SG&A] as a percentage of sales and that internet sales increased as a percentage of total sales. What follows explains why those items are important to Best Buy's valuation.
Can Best Buy Increase Sales?
While Best Buy has some tough competitors in Amazon.com Inc. (NASDAQ:AMZN) and Wal-Mart Stores Inc. (NYSE:WMT), neither of them had the merriest of Christmases either. For the 14-week period ended January 31, 2014, Wal-Mart's SSS were down 0.4%. Though Amazon's Q4 2013 sales were up 20.3% vs. Q4 2012 that was less than the 21.9% increase in its total 2013 sales. One of the most interesting things Best Buy's CEO Hubert Joly said during its holiday sales conference call on January 16 was that the company had taken market share. That suggests things are starting to turn around.
My valuation of $49 assumed Best Buy could grow sales beginning this year. But, its value is still $40 under a more pessimistic sales scenario: sales fall 2% this year, fall 1% next year and are flat for 3 years before slowly increasing to the growth rate of the economy in year 10.
The keys to that $40 value are reducing SG&A to 19.0% of sales and increasing its sales-to-capital ratio from 2.4 to 3.8.
Can Best Buy Sufficiently Increase Its Adjusted Pre-Tax Operating Margin?
While I am not expecting much if any reduction in SG&A in its just completed fiscal year because of various initiatives, I do want to hear that the Best Buy will begin to take steps in that direction later this year.
In November 2013, the company's SG&A was 20.6% of sales on a trailing-12-month [TTM] basis. Reducing it to 19.0% would enable it to increase its adjusted pre-tax operating margin from 3.68% to 5.32%--the 10-year target in my valuation. Since SG&A was less than 19% in fiscal years 2007 and 2008, this seems doable.
By the way, in calculating the current adjusted pre-tax operating margin, I added back goodwill and capitalized operating leases which increased EBIT $485 million for the TTM ended 11/2/13.
Can Best Buy Increase Its Sales-to-Capital Ratio?
The key to this is a higher percentage of internet sales. If Best Buy can increase online sales to 15% of domestic sales, it has a real shot. So, I will be very interested in hearing what Best Buy says about its internet sales.
Disclosure: I am long BBY. 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.