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Behind the Best Buy (BBY) numbers: The earnings beat knocked out by the retailer was boosted by...

Behind the Best Buy (BBY) numbers: The earnings beat knocked out by the retailer was boosted by a favorable tax rate, 30.6% compared to 34.6% previous. In addition, a seemingly strong free cash flow number is blunted by factoring in the large jump in account payable to $1.2B from a $561M a year ago. Shares +0.7% premarket.
Comments (11)
  • Clumsy Rick, CFA
    , contributor
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    Payables were 5.7 BN, down from 6.1 BN a year ago. The 1.2 BN decline in the cash flow statement is from Q4. And its already factored into the cash flow. What see is what you get.

     

    Tax rate took off a nickel. EPS still well ahead of expectations.
    22 May 2012, 08:58 AM Reply Like
  • Seeking Beta To Your Alpha
    , contributor
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    You didn't factor in the extra week into your calculations.

     

    http://reut.rs/JMr9AZ

     

    No value judgements here either way. Not saying that results would have been terrible if the numbers were controlled for the extra week, not saying that the extra week is negligible.

     

    Just saying that if you're going to run comparisons, they should be based off the same baseline - otherwise the comparisons don't necessarily work.
    24 May 2012, 02:22 PM Reply Like
  • Seeking Beta To Your Alpha
    , contributor
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    I crunched the numbers and the extra week and the tax differential paint BBY's Q1 in a very different light.
    24 May 2012, 08:57 PM Reply Like
  • Clumsy Rick, CFA
    , contributor
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    Actually, I saw the extra week and had accounted for it. I don't like the way they broke out the results either (why make someone ask for the impact on the call?), but the fact is that they told analysts there would be an extra week in advance. In hindsight, I see not all analysts factored this into their estimates so the consensus number was a hodge-podge. Either way, I dont think it mattered. There was a vocal chorus calling for a big miss that didnt materialize. That, combined with an interim CEO that is at least saying the right things, is why the stock has done well since the report in a down market.
    25 May 2012, 08:43 AM Reply Like
  • Seeking Beta To Your Alpha
    , contributor
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    Rick, after you average out the extra week, BBY ends up with Q1 revenue of $10,780, not $11,610 as reported, which ends up being around a 5 percent drop, not a 2 percent gain.

     

    EPS ends up being $0.38 cents (GAAP) and $0.62 cents (non-GAAP, excluding restructuring charges) after you control for the extra week and for the tax differential.

     

    Two keys points here: 1. BBY management made the decision to sacrifice one week this year to boost Q1, which will put pressure on two quarters this year, and extreme pressure on the one quarter that will lose a week (with the Q1 figures in context, now how realistic is it to believe that BBY will meet yearly earnings targets?); 2. when a company starts playing games with reporting periods, it starts to call into question exactly what other tricks its been playing with its numbers (insiders know exactly what games are being played and the flight of top officers from the company over the past two months speaks volumes).

     

    You're right that the big miss didn't materialize and that the stock has done very well in a very tough week. Remember though, very few stories highlighted the tax differential and extra week as issues. To date, I've seen no article that calculated the effect that the extra week and tax differential had.

     

    While the base-lined Q1 figures don't show a company that will be bankrupt tomorrow, they do affirm that BBY is a company that is a slow in decline. You'll note that all of the less than positive numerical indicators from the Q1 call (i.e. shrinking margins, same store sales figures being down, increases in SG&A, etc.) were all figures that would've been less affected or even immune from the extra week and tax differential, because of the very nature of their calculation. The results were not a "mixed bag" as many would have you believe, because after you base-line the numbers, the results all point to a company in a slow decline...
    25 May 2012, 09:05 AM Reply Like
  • Matt Blecker, CFA
    , contributor
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    Good point about the extra week. Although the impact on full year earnings is negligible. Even w/o the extra week EPS would have still been very respectable, due to the much lower share count.

     

    I wouldn't judge too much on one quarter. This particular quarter is usually the one with lower margins/EPS if you look back and examine past years. But the company has performed decently throughout the the last few years. Not nearly as well as during the housing boom, but during a major Recession and near Depression in the US, and now an extremely difficult environment in Europe and slower growth in China, Best Buy is still delivering decent numbers. Growth overall the last few years has been flat, and operating margins have been in the 3.8%-4.8% range, which is lower than the mid 2000s but still very respectable for this type of retailer. To put this in comparison Costco's margins are about 2.7%.

     

    Please note this means adjusting fiscal 2012's OM for the non-cash, one-time goodwill impairment charge related to Best Buy Europe

     

    I believe when the housing market recovers, BBY will benefit through greater electronics and appliance sales. Remember, starts are only 50% of where they are in a normalized environment. While some of BBY's problems have to do with competition from Amazon, much has to do with weak sales of large durables. BTW, if you check market share numbers using Amazon's sales and Dept of Commerce numbers, BBY has not really lost much share. There flat revenue growth and lackluster same store sales have more to do with the weak market for consumer durables and weak housing market IMO than they do with competition from Amazon. Do you really think once the housing market recovers that ALL consumers will opt to purchase washers, dryers, televisions, etc...online? Some will opt for bricks and mortar and the convenience and comfort of having a product and warranty explained as well as returning and exchanging.

     

    The change in reporting period isn't really a big deal. It makes more sense for BBY to end its fiscal year at the end of January when many retailers do. I believe WMT does.

     

    In addition, Amazon is having difficulty making a profit, some of which has to do with increasing shipping costs, and some of which has to do with increasing fulfillment and tech/content costs. They even say in their filings that costs will remain elevated for some time. Amazon also takes twice as long to pay its suppliers as BBY. Eventually these issues will hurt Amazon and most likely, benefit Best Buy.

     

    Lastly, what I also think most investors are missing and the major reason BBY beat is the lower share count due to the company's repurchase program. Their ability to repurchase shares stems from their huge FCF generation. Due to the repurchase program, even if revenue and operating margins remain stagnant or at the lower end of the firm's historical range, EPS will still move higher due to the repurchase of shares.

     

    And while in the short-term BBY's stock is being driven by emotion, company turmoil, the difficult economic environment, perception related to Amazon, etc...long term the firm's stock price will be driven by its EPS. Even projecting EPS under a conservative scenario 3-5 years down the road, the company should still deliver $4-5 per share in earnings power. Even using a low multiple the stock could double or triple from these levels.
    25 May 2012, 10:37 AM Reply Like
  • Seeking Beta To Your Alpha
    , contributor
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    Matt,

     

    I respect your analysis, but don't necessarily agree with your position. While I think we both agree that the numbers weren't "terrible", they do paint a dramatically different picture than the one that was reported when base-lined properly. Shares outstanding still stand at 342.20 according to Google finance. This means that EPS ends up being $0.38 cents (GAAP) and $0.62 cents (non-GAAP, excluding restructuring charges) after you control for the extra week and for the tax differential. This is significantly different than the $0.47 cent and $0.71 cent figures that were reported.

     

    I also don't disagree that it makes more sense for BBY to have shifted their earnings out a week to bring it in line with other retailers. The "gaming of reporting period results" that I'm referring to in my comment above relates to the fact that the numbers that were reported don't control for the additional week. Rick's comment above recognizes that BBY was less than forthcoming about the additional week's impact until it was specifically identified. Those kinds of games make investors wonder exactly what other information Best Buy management is being less than forthcoming about.

     

    Also, an extra week isn't going to necessarily make or break a company for a full year, but note that without the extra week, BBY would have shown a significant decline when compared to the same period last year. The company won't have the same luxury for the next three quarters of earnings, and if history is any indication of how the Best Buy will fare moving forward, then that sends a signal of future decline.

     

    I don't discount the points in your comment above though but I would pose two questions to you: 1. Do you foresee an economic recovery with strong housing growth over the next year or two? 2. Do you believe that Best Buy's current management has the capability to transform the company to meet the changing face of retail?

     

    I believe that BBY might have a future in the near term if the answer to the two questions above are a yes. The problem is, I don't believe that the answer to both questions will be a yes... Of course that's just my opinion - and right now, it appears that investors are siding with you. BBY is up almost 2 percent today.
    25 May 2012, 11:11 AM Reply Like
  • Matt Blecker, CFA
    , contributor
    Comments (168) | Send Message
     
    Addressing each paragraph above:

     

    1) Good point about the 9 cent difference. However, this does not make a major difference for the full fiscal year as it accounts for less than 3% of projected earnings. Secondly, much of the restructuring is non-recurring as BBY is implementing an $800 cost savings plan over the next 2-3 years.

     

    2) I think you are focusing too much on the extra week. Yes it is a factor, but overall, it doesn't much affect Best Buy's earnings power or free cash flow generation.

     

    3) You are correct. Best Buy's earnings year-over-year for the quarter were slightly worse. However, if you examine past reporting periods the margin was well within a normal range. While revenue growth is slower, which is somewhat due to a weak environment in Europe, somewhat due to competition from Amazon, somewhat due to the weak housing market within the US, and somewhat due to slower growth in China, I do think within the next 2-4 years much of these issues will be in Best Buy's favor, and revenue will grow moderately over the long-term. Even throughout the last 3 years, revenue has still grown, albeit it slowly.

     

    4) 1-2 years is optimistic in housing, but I think it will happen within 3. JP Morgan wrote an excellent report on the state of the housing market several months ago which I encourage you to read. Factoring in the remaining excess inventory, normal household formation, and weak housing starts, they concluded that housing will begin recovering within 3 years. I concur with their analysis.

     

    I could talk about a lot of factors. But I remain bullish on Best Buy from these levels due to the following factors:

     

    1) Huge free cash flow generation in a challenging environment over the past 3-4 years which includes a near Depression in the US, and certainly a Depression in housing, a near crisis in many European countries, competition from Amazon, and recently, slower growth in China.

     

    2) Share repurchases which will help grow EPS even if revenue growth remains slow and operating margins are at the lower end of the range

     

    3) Cost cutting measures and lower cap ex will help the bottom line

     

    4) An eventual recovery in housing should help sales of appliances and televisions

     

    5) The firm has not lost as much market share as people think if the numbers are studied closely. Slower revenue growth is at last partly due to weak consumer durable sales in general over the last 5 years

     

    6) Amazon's difficulty generating solid operating margins and potential free cash flow problems if you factor in their rising payables period

     

    7) International exposure which over the longer-term has grown and should continue to grow at least moderately, which primarily includes for Best Buy mobile phone demand in Europe and appliance demand in China

     

    8) The margin of safety present at current levels as the stock is already pricing in a really bad scenario

     

    I appreciate your feedback.

     

    I could go on but I think you get my point. Lol.
    25 May 2012, 07:28 PM Reply Like
  • Seeking Beta To Your Alpha
    , contributor
    Comments (450) | Send Message
     
    Matt,

     

    A $0.09 cent swing on a quarterly earnings call is pretty big in my book. Take out the tax differential, and I would consider a $0.4 cent swing significant at well.

     

    Not sure if BBY would have been in the green during a week when most other stocks got hammered by news coming out of Europe.

     

    Whether it will make a difference for the full year remains to be seen. A $0.4 swing over four quarters would still average out to $0.1 cent, which could be the difference between missing, meeting, or beating expectations.

     

    I clearly won't change your mind, but just something to consider.
    25 May 2012, 11:25 PM Reply Like
  • Matt Blecker, CFA
    , contributor
    Comments (168) | Send Message
     
    I disagree as I am not long BBY bc they will beat short-term quarterly earnings expectations. As of now the firm is priced as if earnings will decline 50%, so a few cents means nothing to me long-term.
    5 Jun 2012, 12:57 PM Reply Like
  • Matt Blecker, CFA
    , contributor
    Comments (168) | Send Message
     
    Thanks for correcting Seeking Alpha's flaws Clumsy Rick. From where does Seeking Alpha get this "sheeple based crap?"

     

    Without the non-recurring restructuring charge, earnings before tax would have been $362 million for the quarter.

     

    The difference in the tax rate was 4%, which equates to $14.48 million dollars or about 4.2 cents per share. For a company that is likely to earn at least $3.50 per share this fiscal year, 4 cents is negligible.

     

    And the accounts payable did go down as you pointed out. The payables period for the company has been relatively steady the past decade and was about 49 for fiscal year 2012. Unlike Amazon's payables period which has increased significantly the past decade and was over 90 for fiscal year 2011.

     

    If anything, free cash flow is slightly understated because the company paid down their accounts payable at a faster pace this year than last. True free cash flow under my calculation was very respectable $248 million for Q1 2013.

     

    The balance sheet remains strong with net debt before minority interests of $513 million.

     

    And what most investors are missing is the lower share count, which was down nearly 15% year-over-year! Long-term the stock price will be driven by earnings per share. Even if net income and revenue growth remain slow or stagnant, because of the firm's impressive free cash flow they will easily be able to shrink the share count.

     

    Best Buy's operating margin has an approximate range between 3.5% and 5.5% the past 15 years. Throughout the credit crisis, and even now with an ugly environment in Europe and slowing growth in China, the company has still delivered decent operating margins, including a 4.5% operating margin for fiscal 2012 (after adjusting for non-cash goodwill impairment).

     

    Revenues this year should be about $51 billion. Even using the low end of operating margins, say 4%, a similar interest expense to last year, and a normal 35% tax rate, the firm should still generate net income of approx $1.25 billion. Free cash flow should actually be slightly better than NI because of the firm's lower cap ex as depreciation at least for the next few years should exceed cap ex.

     

    Using the midpoint of the firm's repurchase target, at this price they should be able to decrease the share count to about 300 million by this time next year This would give Best Buy earnings power in excess of $4 per share by next year. If the firm keeps retiring shares at such a rapid pace, EPS should increase substantially even with operating margins at the lower end of the range and very slow revenue growth.

     

    I think investors are also missing that Best Buy will benefit from an eventual housing rebound. Sales of large durables such as TVs and appliances remain below 2007 levels. When these sales begin to improve, which will probably coincide with a housing rebound within the next 2-3 years, surely Best Buy will benefit. Not everyone will buy large durables online as many will opt for the comfort and convenience of a bricks and mortar retailer, especially older shoppers.

     

    I would not be surprised if BBY's earnings power 3-5 years down the road is $5-6 per share. Using a multiple of only 10x earnings, the stock could triple from current levels in the next 3-5 years.

     

    Best Buy is Circuit City. Nope. Circuit City was never as profitable as Best Buy and struggled to be profitable even during the housing bubble.

     

    Best Buy is Blockbuster. Nope. Well before Netflix, Blockbuster struggled with profitability. The firm also had huge leverage and carried an interest expense which was nearly as much as Best Buy's today, despite Best Buy's revenues being 13x more.

     

    Best Buy is not even Radio Shack as RSH is much more dependent upon domestic mobile sales and has less product diversification than Best Buy and lacks a significant presence abroad. RSH's operating margins have also had a huge range over the past decade, where as Best Buy's have been much more stable.

     

    Please let the "hate comments" begin. Lol.
    22 May 2012, 02:31 PM Reply Like
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