Is Best Buy's Business Model Permanently Broken?

 |  Includes: BBY, BJ, COST, EBAY, OSTK, TGT, WMT
by: Brian Gorban

Best Buy just reported another quarterly miss on both the top and bottom line and the future doesn't look to be much better. They came in with revenues at $11.3 billion, below the $11.5 billion consensus, and easily missed earnings estimates of $.53 by coming in at $.47. Going forward, they expect full year revenues in the $51 billion to $52.5 billion range, the midpoint slightly below consensus estimates, and earnings estimates when taking out the non-recurring share buybacks adding $.20-$.25 per share of $3.10-$3.40, well below the current $3.70 consensus estimate. This lead me to ask is Best Buy a buy here or a classic value trap where other retailers are stealing their business? I've concluded for now it's a value trap and not a buy.

On the surface, the valuation metrics look compelling with Best Buy trading under 7.5x price/earnings, .2x price/sales, and a dividend yield with yesterday's drop of almost 2.8%, well-above the S&P 500 average of 2.2%, and strong free-cash flow of just over $1 billion annually. However, the good news seems to stop there as the company has very little net cash left at $32 million due in large part to many ill-timed purchases of their own stock totaling over $2 billion in the last year at an average price of $33.65. That's a drop of almost 35% from the current trading price, meaning approximately $700 million in book value has evaporated. Moreover, same stores sales came in at a horrible negative 2.8%, and gross margins continue to fall as there were more promotions needed to make sales.

Back in 2009, it was widely thought that with the bankruptcy of its largest competitor, Circuit City, Best Buy was going to march higher. However, it has been anything but positive as the stock has fallen almost 50% since that time from the low $40's to its current $23/share price. It seems that what has been happening is that most consumers are still taking advantage of Best Buy's knowledgeable and friendly staff and then buying it for less at Costco (NASDAQ:COST), Wal-Mart (NYSE:WMT), Target (NYSE:TGT), eBay (NASDAQ:EBAY), BJ's Wholesale (NYSE:BJ), (NASDAQ:OSTK), or their other favorite retailer who has the lower-margin higher volume business model.

Of the lot, i think Wal-Mart looks like a buy here at $51/share as it trades under 11x price/earnings, 4x price/sales, has a much more diversified revenue stream, and equally nice 2.8% dividend yield. Target is also fabulously run and has value trading at 12x price/earnings, 5x price/sales, and 2.4% dividend yield. However, I'd wait to buy at 11x price/earnings, translating to $46.50/share, since I don't see the reason to pay a premium over Wal-Mart. Fantastically run Costco has a much smaller yield of 1.2% and trading at a much richer 25x price/earnings, while BJ's, eBay, and Overstock have no dividend yield whatsoever which leads me to give them a no-buy in this volatile market where dividends have been providing great protection in this environment.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WMT, TGT over the next 72 hours.