Best Buy (BBY) is a multinational consumer electronics, mobile phones and entertainment products retailer, which has both brick and mortar outlets, as well as an online presence.
The top five consumer electronics companies are Best Buy , Wal-Mart (WMT), Amazon.com (AMZN), Apple retail stores (OTC:APPL) and Target (TGT), in descending order with respect to sales. Among these five, Amazon.com and Apple retail stores have shown the largest increase in sales in 2011 i.e. 51.5% and 29.1% respectively, as compared to 2010. Best Buy had shown an increase of only 0.2% in 2011, and is rapidly losing its market share to Amazon and Apple retail stores. In 2011, Best Buy's market share is 24% down from 25.6% in 2010. Overall, the industry is showing a trend towards online retailers, as compared to brick and mortar establishments.
What is Wrong with Best Buy?
- Online stores like Amazon and eBay (EBAY) have a clear edge over brick and mortar stores in terms of costs. Best Buy has on average 58,000 square feet stores that mean high overhead costs, high labor and inventory costs. The playing field does not get level, even after state sales tax on the dot-com competitors is taken into account.
- Best Buy's losses are primarily being attributed to the fact that consumers come to their outlets and try out/test products. These trying out of products does not convert into sales, as customers return home and buy the products from elsewhere e.g. at discount outlets, or places who have comparatively lower prices. Consumers are far more price sensitive these days owing to the high prevalent unemployment situation in the U.S and the discouraging global economic conditions. Apparel and book retailers are less affected by this "show rooming" phenomenon. Prices at Amazon are 3% less than Best Buy on key SKUs, according to JPMorgan.
- Bad customer service seems to be at the core of the problem. Best Buy uses very aggressive upselling tactics that often annoy customers. This is a very significant issue because bad customer service was one of the reasons that a similar company, Circuit City, had to close its doors three years ago. Moreover, according to some customers, the salespersons know more about upselling than regarding where to find a particular thing in the store.
- Even the employees are not happy. Some state that the discounts they get on products due to being a part of Best Buy are so nominal, that even they can find better deals online. Some employees are even unhappy about the aggressive upselling methods they have to employ at the stores.
- There are even issues with the handling of orders. Christmas time is a key period for retailers, and it is during the last Christmas season that Best Buy was involved in a major mistake. It had to cancel some orders at the very last minute, citing the reason that they could not fill the orders due to high demand for those products. This reflects very poorly on the already struggling company, as competitors like Amazon do not take orders in the first place, if they cannot be filled.
- The buyback protection program is ridiculous. The company advertises this program as a protection for customers from product obsolesce. In this program, when a customer buys a product, he/she can pay an additional fee that gives him/her the right to return the product at a lower price. Best Buy gives that customer a gift card of that value. Customers think this is ridiculous because they can get far more if they sell the product, on a site like eBay, compared to the gift card's value. Similarly, Amazon has far better and convenient exchange and return policies than Best Buy.
The Right Steps:
- Smaller standalone mobile stores.
- Reducing the size of existing stores and copying Apple store's layout. To attract customers, the retail outlets would be 20% smaller and have help desks, more places to pay within the store, and knowledgeable salespersons who can guide customers. Though the last CEO emphasized a lot on TV sales, it is good that these new smaller stores have a smaller place allocated to TVs, as they contribute less to the bottom line due to TV sets being much cheaper now. More space is being given to "hotter" products like smartphones and tablets. This is a good move because they form the largest source of revenue for the company (43% of domestic revenue and 62% of international revenue in first quarter results).
- Ex-CEO Brian Dunn said that they could double online sales in three years.
Fiscal year 2012 for Best Buy ended with a profit margin of -2.43%. However, 1Q2013 showed slight improvement with a profit margin of 1.36%, almost back to the level before the drastic decline in late 2011 and early 2012. Cash flow levels are healthy too i.e. $4 per share.
Despite better profits, same store sales have been declining over the years. The quarterly same store sales results are shown in the bar chart below. The last quarter showed a very large decrease 5.3% (the biggest so far). This shows that revenues have been falling, but costs have been falling more, thus resulting in the narrow profit margin of 1.36%.
The next five-year growth rate for Best Buy is 5.68%, compared to Amazon's massive 32%, TGT's 11% and eBay's 13%. If the turnaround attempts are successful, this figure might reach double digits.
The debt-to-equity ratio is not that high, 47%, compared to WMT's 74% and TGT's 110%.
It has a forward dividend yield of 3.1%, which makes it a good investment for income investors. WMT offers 2.2% and TGT offers 2.5%. Best Buy is expecting share repurchases of roughly $750 million-$1 billion in 2013.
Best Buy faces tough competition from Amazon and eBay for e-commerce. Best Buy needs to offer its customers some form of incentive to buy at its stores e.g exclusive deals. It can also expand its offerings to include something that would boost sales, and would be less susceptible to show rooming e.g. furniture. It should also focus on customer service because customers have been complaining that they get better treatment/convenience by buying online, at sites like Amazon, than at physical Best Buy stores. Another aspect it can look at is to develop its own e-commerce to an extent that it can at least compete with Amazon, if not beat it.
As part of its turnaround strategy, it is planning to do the following:
- Lay off 2,400 employees. This comprises of 600 employees from the Geek Squad technical support division and 1,800 store workers. This makes about 1.4% of its total workforce of 167,000.
- In March, the company said it would implement a restructuring, designed to reduce $800 million in costs by 2015. This cost cutting involves plans to close 50 stores in 2013. 41 have already been closed as of May 12, 2012.
- Revise store formats to facilitate customers and to improve customer experience.
- 100 new U.S. mobile stand-alone stores in 2013.
- Plans to grow online revenue from the Domestic Segment by 15 percent in 2013.
- Growth initiatives in China. The company wants to open 50 new Five Star stores in 2013 as part of a plan to open a total of 400-500 stores by 2016. It currently has 204 stores.
There are also rumors that if Best Buy is not able to recover, the founder might take it private. Founder Richard Schulze resigned from the board earlier this year, and is currently considering what to do with his 20% stake.
Since the start of 2011, it is down 37% to date. The stock is currently trading at a P/E of 5.82x and EV/EBITDA of 2.42, which is very low considering the fact that it is the industry leader in terms of sales. Our target price is $21 (forward P/E of 5.82x and average estimated EPS of $3.62 for year ending 2012). The current stock price is $21.59.
We recommend holding the stock and waiting for the results for the second quarter in August. Those results will be an indicator whether the strategies being employed for the turnaround are good for the company's health or not. If the results are positive, this could be a very interesting turnaround story.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.