I have never been a big fan of financial media. In my opinion, investors would be much better off if they ignore the noise radiating from these shills of the financial services industry. What irks me even more then the usual hype of "buy this" and "buy that" (almost always after the stock has appreciated) is when outrageous claims are made, bullish or bearish. The most outrageous that I have seen to date is by a blogger over at Forbes named Larry Downes. On Jan 2, Mr. Downes posted an article entitled "Why Best Buy is Going Out of Business...Gradually".
Mr. Downes starts the post with the claim that Best Buy (BBY) is heading for the exits. He is not sure when, but it is only a matter of time, his guess being a few more years. I probably should make mention before I go further that Mr. Downes is an internet industry analyst and consultant (I am not quite sure what that means though). He then proceeds to reference a few key metrics. The metrics that he points to are a) that despite the loss of competitors such as Circuit City, BBY is losing market share, b) its last earnings announcement disappointed investors, c) in 2011, the stock lost 40% of its value, d) forward P/E is 6.23, e) its market cap is under $9 billion and that according to the TheStreet.com, its average analyst ranking is a B-.
Mr. Downes also references an article in the WSJ from March 4 2011 that the worst is yet to come for BBY. However, he then states that the real reason for the company's decline, in addition to the "metrics" he states, is the in store (and online) shopping experience. He then recites a story about shopping at a BBY store with a friend and how the "bad experience" they had as well as a pushy salesman trying to sell some cable service. Then there are four more pages about how bad BBY is in relation to Amazon (AMZN) with regards to customer service (Mr. Downes mentions the problem BBY had meeting some orders for Christmas failing to mention that this was a miniscule percentage of total order received).
So where do I start? I do agree with Mr. Downes on the qualitative aspects of the article, most notably that BBY has had a couple of missteps, all of which are self-inflicted. BBY management does need to improve things such as inventory management and customer service (if we are honest with ourselves, all retailers could improve customer service). And AMZN is really a thorn in the side of all retailers, not just BBY.
Where I take issue with Mr. Downes is the quantitative analysis and claim that BBY is on the way out. Obviously, he has never examined any balance sheets or cash flow statements. Let's examine his quantitative points. First, he notes that BBY is losing market share. It is true that BBY has lost some market share. In December 2010, BBY management noted that market share slipped 110 basis points or 1.1%. What Mr. Downes fails to realize is that market share fluctuates and that while no management team or investor likes to see any decline, in the case of BBY, a 1.1% drop in market share has more to do with the weak product cycle in electronics, the economic environment and the natural business cycle. Companies, like the economy as a whole, face headwinds and tailwinds, uphill and downhill (sometimes flat). That is the nature of business. It would be great if a business saw nothing but a tailwind, downhill on the way to ever increasing profits. This just isn't the case.
With regards to a disappointing earnings announcement, yeah, so? Any investor who gets nervous because a company missed "analyst" (I use the term loosely) estimates, needs to rethink being an investor in equities. I like to think SA readers are smarter than the average investor and therefore dismiss such short-term thinking. Also, Mr. Downes mentions the forward P/E of 6.23 plus the market cap under $9 billion as well as the analyst ranking on TheStreet.com of B-. All of which are trivial statistics at best.
I am unsure how Mr. Downes derives bankruptcy for BBY from an earnings miss, low forward P/E and market cap (40% drop in stock price) relative to peers, B- analyst ranking plus the qualitative problems he mentions, of which I admit have merit. However, this is no reason to claim BBY will be gone in several years. If those reasons led to bankruptcy, Wal-Mart (WMT) would have been gone by now (having has some management missteps over the past several years and a low valuation relative to peers).
Here is the real story and all Mr. Downes had to do was take two minutes to look at the numbers. Examining the balance sheet of BBY as of November 26, 2011, it is clear that BBY is not in any danger of bankruptcy any time soon. Personally, in analyzing retailers like BBY, I like to see inventories and receivables greater than accounts payable. When this is the case, as it is with BBY, I feel that the investor is able to disregard the large accounts payable balance as a non-concern. Looking at the long-term debt situation, BBY has a debt/equity ratio of approximately 35 and more cash on the balance sheet than long-term debt.
However, the best thing about BBY that investors should take note of is that it is a cash cow. Through the fiscal third quarter of 2012, BBY had free cash flow of $2 billion. This means that BBY, with a market capitalization of $8.36 billion as of January 4th, 2012 is selling for about 4x its free cash flow. Also, management has been putting that cash to good use, buying back shares and increasing the dividend (last increased on June 24, 2010. As of Jan 4th, 2012, yields 2.7%). It would not surprise me if management increases the dividend this year as well, as there is plenty of cash to do so.
On a side note, an article published on Jan 4th on Bloomberg.com discusses that private-equity companies may be interested in BBY. Although I don't think a buyout is likely (founder and chairman Richard Schulze owns about 20% of the stock, which Bloomberg mentions), it would not surprise me if the PE firms start hovering, especially given the potential upside for a buyer.
So no, Best Buy is not on its way out. There are other good aspects of BBY that I didn't go into, such as the company's mobile phone business. Does BBY face headwinds though? Yes. However, if you are like me in thinking the economy will be better than expected this year and that big-box retailing is not dead just yet, BBY should make a quality investment.
Disclosure: I am long BBY.
Additional disclosure: Took a position on Jan 4th, 2012 and will be adding to the position over the next couple of weeks.