mikelinnyc's  Instablog

Best Buy:  An exercise in valuation
 
            BBY has focused the last few years on expansion, in what looks to be a desperate hunt for new revenue drivers. In the last fiscal year BBY opened 123 new stores in Europe alone, but even a few years into this aggressive international expansion the firm has not seen significant impact to their bottom line.  While 35% of firm revenues come from abroad, these stores abroad represent a paltry 3% of operating profit.  BBY’s recent exit from both China and Turkey speak to the difficulty they have had in growing internationally, as well.

BBY's Same Store Sales numbers provide a bit more color to its business deficiencies.  Product-segmented SSS data shows that approximately 56% of all product categories had a negative 3 year average growth, demonstrating an inability to shift the product mix in existing stores to capitalize on changing consumer tastes.  In an attempt to identify new revenue streams, management has looked to expand the brand through acquisition, but given the lackluster performance of existing stores, BBY should focus on how to differentiate its product mix in a way that can be more profitable.    

A warning sign of trouble is developing for BBY with significant appreciation of inventories, as in the last fiscal year inventory grew at a rate that was 7.19% faster than sales.  Coupled with customer receipts (A/R) that have ballooned over 3x in just as many years, BBY is showing signs that it is unable to maintain its customer base and has a tangible threat of an inventory write-down. 

            The relatively low EV/EBITDA multiple of 3.08 reflects warranted concern that BBY is not in a good position for growth, given its inability to drive sales and a grim outlook for a significant portion of the markets where it currently does business.  The long-term portion of BBY debt is also trading at a sizable discount, as bondholders drive 5 and 10 year CDS spread values up as they look for protection.  Going concern is not yet a threat, but management must make significant moves in order to compete in such a highly competitive retail space.

Using the average three year SSS growth numbers as an indicator for the direction of future revenues, BBY will end fiscal 2012 with near flat sales results, and with such an aggressive expansion strategy will have to find ways to drive the bottom line inspite of increasing SG&A costs.  Using the EV/NTM EBITDA multiple of 3.08x, which fairly prices in market concern in BBY’s ability to improve the bottom line, the target price for BBY is around $22.00 for the end of this fiscal year, with a further decline developing from the potential of either inventory write-offs or further divestment of unprofitable segments in medium term. 


Disclaimer:  I do not have any positions in any of the securities mentioned in this post, nor do I have any intention of taking a position in the next 72 hours.