Is Best Buy a Value Trap?

Despite the challenges, the company’s solid fundamentals make the stock especially attractive for long-term investors. The shares are trading at a historic low multiple of about 12.5 times estimated fiscal 2009 earnings. ... In more normal times, the stock trades at a multiple from 15 to 18 times earnings. ...

- “Consumers Turned Off? Not At Best Buy,” Barron’s, Saturday March 22

In my Bear Market Talks I’ve been warning people about value traps. A value trap is generally the stock of some well known company in a beaten down industry that looks great by the numbers.

However, this superficial analysis is misleading because the business is struggling so much that numbers are likely to come in mediocre at best - making any real stock gains unlikely.

I think Barron’s fell into this trap with a piece a couple weeks ago recommending Best Buy’s shares, and yesterday’s earnings release from Best Buy (BBY) confirmed this for me (BBY FY 4Q Earnings Release).

Excluding the impact of an extra week in the comparable period last year, revenues grew 9% and EPS 14%. Looks pretty solid, right? However, when you look beneath the surface you can see how much Best Buy’s business is really struggling. The 14% EPS increase was driven almost entirely by a huge share buyback program. There were about 13% less diluted shares this quarter than last. So, when you take out the share buybacks, organic earnings growth, growth in the actual business, was really only about 1%.

Revenue growth, in turn, was entirely a function of adding new stores - 137 in the past 12 months. Same store sales were down .2% - and down .9% in its core U.S. business. That means that stores that have been open for 14 months actually sold less in the just completed quarter compared to last year. Another number that caught my attention was the -4.6% comparable sales in their core Consumer Electronics segment. So Barron’s anectdotal report about 22-year old David Mushrall, and 24-year old Colin Lucas who each recently purchased flat screen TVs doesn’t mean that many others aren’t cutting back on their consumer electronics purchases.

In sum, there are lots of convincing arguments that can be made for Best Buy’s shares on a fundamental basis including: It is down almost 20% from its 52-week high in December; it is trading for only 13 times forward earnings; and it is the leading company in its space. But the weak economy will pressure the discretionary purchases that are their business resulting in lackluster business and stock performance. You’ll have a chance to buy Best Buy at a better entry if you’re patient.

On the subject of value traps, also see my “The Limits Of Pure Fundamental Analysis - How Morningstar Gets Things Wrong,” Top Gun FP, September 27, 2006.

Disclosure: Top Gun has no position in Best Buy shares.

Comments

[deaverb]

Mass merchants are cutting into BBY sales on all fronts. Ditto for downloads, though BBY has a great digital site through Digital River. Long term they are under pressure. A lot of their growth has related to the demise of CompUSA, the struggles of CC. With those pretty much gone (CC is just walking around to save on funeral expenses), BBY is challenged with the TRU (Toys R'US) problem of seeing market share taken from them bite by bite....

[billddrummer]

I believe BBY is gaining market share at the expense of the CompUSAs and CCs of the marketplace. It's true that organic growth has stalled, and that sales revenue increases came from new stores. But the company has committed to continuing aggressive store openings for the coming fiscal year, as well as increased investments in IT, international infrastructure, and new market penetration (Mexico and Turkey are next). When the smoke clears and the economy rights itself (that will happen, but not till 2010), BBY will be well-positioned to benefit from fatter consumer wallets.

The other item at work is the consumer electronics product cycle. No high-demand products are on the horizon this year, so 'must-have' new products aren't going to drive store traffic as it did in the previous 3 years. New products will start showing up in late 2008, just in time for the holidays. Look for increased connectivity-based products that integrate PC, laptop, gaming and TV content, to provide consumers with maximum flexibilty for consumer electronics applications.

[Mike Kayes]

The key with regard to Best Buy, during this difficult retrenchment in consumer spending, is how are they doing relative to competition? BBY is gaining share, is investing significantly more than the competition, and this will drive future growth once consumer spending rebounds. The stock is a long-term buy!