Why Now's The Time To Buy Best Buy

May.13.12 | About: Best Buy (BBY)

Best Buy (NYSE:BBY) hit new 52-week lows on Friday, closing at $19.28. Other than a very brief period during the depths of the 2008 recession, Best Buy had not dipped below $20 since the company's meteoric rise about a decade ago. The primary catalyst for Best Buy's underperformance on Friday was probably a new research report by Gary Balter at Credit Suisse (NYSE:CS) in which the analyst downgraded Best Buy to neutral and cut its price target from $32 to $20.

The rationale for the downgrade was that the scandal surrounding former Best Buy CEO Brian Dunn's dismissal is causing the company to lose focus. Dunn allegedly used company resources in the course of having an affair with a female employee. However, the exact details surrounding his resignation and the board's investigation remain unclear. Furthermore, while interim CEO Mike Mikan has plenty of leadership experience from his time at UnitedHealth (NYSE:UNH), he does not have experience in the electronics retail business. Thus, Balter is correct to say that the company faces some execution risk in the near term, which could undermine performance this year.

That said, Mikan has served on the Board of Directors for four years, so he is familiar with the company. From his initial remarks, he seems to have his priorities in the right place: continuing to provide good customer service and investing in growth businesses like Best Buy Mobile and Five Star (in China). It may take a quarter or two of steady results to convince onlookers that Best Buy is not imploding. However, with a P/E ratio lingering around 5 and analysts estimating roughly flat profit over the next two years, Best Buy's valuation is very compelling. The company recently closed 50 big box stores, which represented the first stage of a multiyear plan to cut $800 million in expenses. As these cost cuts roll through in future years, profit growth will resume in all likelihood.

While Best Buy clearly faces significant competitive pressures, the company also has some things going for it. Amazon.com (NASDAQ:AMZN), perhaps its biggest competitor, has long benefited from its ability to avoid collecting sales taxes. However, states have slowly been reclaiming their tax privileges, and over the next four months, Amazon will begin collecting sales tax for purchases in California and Texas. Since these two states comprise roughly 20% of the US population, this is a significant change. Best Buy will be able to compete more effectively with Amazon when the two are on even playing ground. E-commerce is one of Best Buy's focus areas in its turnaround plan, and so I expect strong gains in that area over the next year or two. This provides some upside for the 2012 holiday shopping season in particular.

The case for Best Buy as a turnaround story can be understood in relation to the case against Radio Shack's (NYSE:RSH) turnaround. Whereas Best Buy has been able to maintain more or less constant profits in the face of various pressures, Radio Shack has seen its profit plummet in recent quarters. At a few points in time, I've been interested in Radio Shack, but I've never pulled the trigger. While the company trades below book value, the outlook keeps getting worse, suggesting that whatever value remains in the company could quickly be destroyed. Profit expectations for this year and next year have been sliced in half over the past three months, so that the stock still trades with a mid-teens P/E ratio.

Best Buy has issues to address, but unlike Radio Shack, it is doing so from a standpoint of solid profitability. Last quarter's $2.47 adjusted EPS figure was a strong sign that Best Buy is not dead. Furthermore, the company is far more diversified than Radio Shack, providing a cushion against downturns in particular business segments. For patient investors, Best Buy is definitely a buy under $20.

Disclosure: I am long BBY.