With the stock hitting a 52-week low on Thursday, here are five solid reasons investors should be looking at adding to/starting positions in Best Buy (BBY).
1. Concerns over July sales are misplaced. The US Department of Commerce put out its monthly advanced sales report for the month of June on July 14 and BBY shares have been under pressure since, falling 11% over the last couple weeks. This data set showed the electrical and appliance stores channel had a 2.3% Y/Y decline in sales in June, which was slightly worse than May's 1.9% Y/Y decline. While some analysts with a negative view on the stock heading into this report pointed to this data as a reason to sell BBY, this conclusion is erroneous/misleading.
I have been tracking this data and its correlation with BBY sales for years. While there has generally been good correlation with BBY's sales and BBY has been a net share gainer in the channel over time, the relationship broke down last year beginning with Q2 when BBY's sales growth lagged the broader channel by 2.6%. I suspect this was partially due to strong appliance sales that occurred with the government-sponsored rebates. Appliances only make up 5% of domestic sales for BBY but can be a third to half of the sales for a smaller CE chain.
Regardless of the reason for the lag, just as BBY did not participate in last year's strong Q2 sales growth for the channel, the company is not participating a year later (this quarter) in the downside as it does not have the tough comparisons the rest of the channel has. Specifically, if you assume the trend in June's monthly data continues through the quarter, the Commerce Department report will continue to get worse in July before improving in August. However, if we look at the data on a two-year basis and even assume more share losses for Best Buy, Best Buy is still on track for positive same store sales in 2Q11 of perhaps 1-2%.
2. "Amazon (AMZN) Bills" proposed in state and now the federal legislatures. BBY is making a big push into online sales as a way to combat inroads being made by Amazon and others. BBY already has the highest brand recognition for consumer electronics, and by carrying a wider selection of SKUs online than in its stores, the company can keep prices more competitive with online retailers and retain more customers. However, BBY's efforts are hampered by the inherent advantage online retailers have in that online retailers are not required to collect sales tax most states. This is changing in a hurry.
Driven by the need to increase revenues, states are passing laws to force Amazon and other online retailers with warehouses or affiliates in the states to begin collecting taxes. The number of states having moved this way or planning to is large, including IL, CA, CO, NY and many smaller states. These are taxes that the individuals owe to the states and should be paying via their tax returns, but most individuals never do. Amazon has responded by cutting ties with affiliates in these states or by threatening to close warehouses, but this effort to level the playing field and raise tax revenues is now being taken up in Congress. In the coming weeks, Assistant Senate Majority Leader Dick Durbin plans to introduce the Main Street Fairness Act bill, which would set up a framework for online retailers to collect state taxes no matter where the online retailer is located. Given most states' dire need for revenue, this bill could have substantial momentum. Should it become law, it would provide substantial benefit to BBY.
3. Strong euro and GBP driving international sales and profits. Carphone Warehouse recently reported sales results for its most recent quarter ending June 30. Given the two-month lag BBY has for incorporating BBY Europe's business into its reported results, these reported figures will be the basis for what is reported in BBY Europe for BBY's Q2 ending August 31.
Many investors appeared to focus on the 3.3% decline in same store sales (SSS) that Carphone Warehouse reported, which was worse than the 1.7% decline reported last quarter. However, there were several other points worth mentioning. First, the total sales growth appears to be nearly identical (up 4%) to 1Q's despite the weaker SSS. This happened because the euro and GBP are showing stronger growth versus the USD this quarter compared to last quarter, and because Carphone Warehouse could be selling more to its franchise/dealers, which are sales that don't go into the calculation for SSS.
In addition to the fact that sales growth appears the same in Q2 and Q1 for BBY Europe (not more negative as we think analysts have suggested), the stronger GBP is driving higher margins for the division. This is also supported by Carphone Warehouse's statements that it expects to meet its financial goals for the year. Based on my calculations, BBY Europe should add $5-10 million to operating income in the quarter. While this is only a 1-2% boost over BBY's total operating income last year, I believe many analysts are assuming BBY Europe will be a drag this quarter.
4. Stock buyback is still underway. While some analysts questioned the fact that BBY already spent $480 million on a stock buyback in Q1, the company still has plenty of free cash flow to keep buying back stock at a high level. Indeed, the company stated it will buy back at least $1.3 billion this year and I would estimate this could go as high as $2.5 billion and still end the year with $2 billion in cash. A catalyst for more buybacks could be refinancing BBY Europe's debt, which Carphone Warehouse said is underway currently.
5. Valuation is insanely cheap. Even on the consensus forecast that I think is too low for this year, BBY is trading at a P/E of under 8x and 3.2 EBITDA. Based on next year, the valuation is even more compelling, but it will be a couple months before most investors start considering 2012 estimates. In my experience, retailers only trade at this kind of valuation when the market either thinks the company is going out of business or earnings forecasts are way too high. I think the latter is definitely not the case. On the "going concern" issue, BBY is the largest CE retailer in the world, with over $55 billion in sales, $2 billion in operating income and perhaps $2-3 billion in free cash flow this year. No matter what you think of the company long term, it's not going out of business anytime soon. The pendulum will swing back from the current maximum pessimism to optimism once again and, even without raising published earnings estimates, the stock could double simply on multiple re-inflation.
Finally, while it's been almost a year since I wrote about BBY as a potential takeover target (Best Buy: The Case for a $20 Billion Retail Takeover) and for a while it was starting to look less likely, the recent decline in the stock to its 52-week low makes me think this is worth revisiting. I think the arguments I made are as relevant today as they were then. In fact, the valuation is even cheaper now than it was then, as the stock is lower and earnings are higher. How easy would it be? Over the last few years, retailers have been getting bought out at 6x-8x EBITDA, which is a discount to multiples four or five years ago. Even assuming only a 4.5x EBITDA, a buyer could afford to bid $40, or a 43% premium to today's price. While I would never buy a stock solely on its takeover potential, I believe investors with a long term horizon should be buying the stock for the same reason savvy buyout firms would: The potential upside versus the potential downside from here seems huge.