Best Buy (BBY) is the world's leading electronics retailer with over 4,000 stores spread across North America, Europe, and China. The stock has been beaten down over the last few years, trading for around $25 a share at the time of this writing. There are certainly headwinds facing the company, and people have not been shy about proclaiming that Best Buy will go bankrupt as a result. But the fundamentals tell a different story. The company has been consistently growing with respect to revenue as well as earnings, and although the growth rate going into the future will certainly not reach the levels of competitors like Amazon (AMZN), I see no reason to expect Best Buy to go the way of former competitor Circuit City any time soon.
Best Buy faces competition on the brick-and-mortar front from companies like Wal-mart (WMT), Target (TGT), and warehouse club Costco (COST). The low prices offered by these competitors have forced Best Buy to lower prices, cutting into profits. On the internet front Amazon is the main competition, also offering low prices with the added benefit of not charging sales tax in most states, although this may change in the future. A common argument used against Best Buy is that people use brick-and-mortar stores as showrooms, ultimately purchasing the products they surveyed online. To some degree this is certainly true, but I believe that a significant percentage of people prefer to make bigger purchases in-store instead of online. This is particularly true for older, less tech-savvy consumers who are overwhelmed with options, and Best Buy specifically targets this type of customer. Best Buy is not a store for twenty-year-olds who grew up with the internet. Best Buy is a store for older people who don't want to degrade themselves by going to Wal-mart. Best Buy is a store that will set up a home network for someone who has no idea what they're doing, even though that information is easily accessible. There will always be people like this, and because of that there will always be Best Buy.
Best Buy's revenue and free cash flow for the last three years are listed below. This data was obtained from Morningstar.
|Free Cash Flow ($Mil)||$1,591||$446||$2,000-$2,500*|
|FCF % of Revenue||3.2%||0.89%||4.0%-4.8%|
Some claim that the story of Best Buy will mimic that of the ill-fated Circuit City. Looking at Circuit City's annual report from 2008, which can be obtained from the SEC database, Circuit City was clearly in decline.
|Free Cash Flow ($Mil)||$111||$30||-$371|
|FCF % of Revenue||0.96%||0.24%||-3.2%|
Circuit City was an inefficient, unprofitable mess, and it was evident years in advance. Best Buy is profitable, generating ample free cash flow and should continue to do so well into the future. The comparison clearly has little merit.
To determine the intrinsic value of a stock I use a discounted cash flow analysis using what I view as fairly conservative estimates. This involves summing all future cash flows generated by the company discounted back to today and adjusted for net debt. I assume that the company will increase revenue at a rate of 3% annually and FCF margin will increase from 3% to 3.5% over the next five years and then remain at 3.5% thereafter, which seems reasonable based on Best Buy's plans to reduce the average size of it's stores. I use a discount rate of 15%. My fair value estimate for Best Buy comes out to $33 per share. Demanding a 25% margin of safety sets about $25 per share as an entry price, which is where the stock sits today.
Best Buy is a stock that has been written off by most but offers a significant upside to the current price. An aggressive share buyback program has reduced the float by about 9% over the last year, and I believe that the risks involved in owning Best Buy are more than compensated by the possible rewards.