Best Buy: The China Trade War Will Affect Upcoming Earnings Guidance

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About: Best Buy Co., Inc. (BBY)
by: SmartStops
Summary

Best Buy is set to report fiscal first quarter earnings results on Thursday.

Analysts expect the company to earn $0.86 per share and that is slightly higher than last year.

The ongoing trade war could have an impact on earnings this quarter and possibly Best Buy’s guidance.

Therisk level is elevated right now based on our proprietary software.

Electronics retailer Best Buy (BBY) is scheduled to report first quarter earnings for fiscal 2020 on May 23. The report is due out before the opening bell and analysts expect the company to report EPS of $0.86 which is a slight increase from the $0.82 the company earned in the first quarter of 2019. The revenue estimate is for $9.13 billion and that is a slight increase from $9.11 billion in 2019.

Over the last few years, Best Buy has been able to grow its earnings, but has struggled to grow its sales at a similar pace. Earnings have grown at a pace of 26% per year over the last few years and they grew by 12% in the fourth quarter. On the other hand, sales have only grown at an annual rate of 4% and they were actually down by 4% in the fourth quarter.

Even the management efficiency measurements are mixed. The return on equity is great at 43.3%, but the profit margin is only 4.6%. The profit margin is likely getting hurt by a couple of different macro trends. Best Buy is competing with Amazon for online electronics sales—this is something most retailers are facing.

Another factor that is hurting the profit margin is the trade war. The ongoing dispute is impacting many retailers with the tariffs raising costs, but it is tough to pass the increases on to the consumer when the marketplace is so competitive. Walmart and Macy’s both issued warnings that the tariffs will impact pricing when they reported earnings during the past week.

In the fourth quarter earnings report that was released in February, Best Buy stated that the tariffs that were implemented in September would only affect approximately 7% of the total cost of goods sold. From the company’s earnings call:

“As it relates to U.S. tariffs on imports of certain products from China, we told you last quarter that we estimate that $200 billion list that went into effect in September touches only about 7% or around $2.3 billion of our total cost of goods sold. Our fiscal 2020 outlook assumes that the tariffs stay at the current rate of 10%.”

As we now know, the rate on the tariffs was recently raised to 25% and then China retaliated with new tariffs of its own. Now President Trump is considering yet another set of tariffs that will affect $325 billion in Chinese goods and the rate will be 25% from the beginning. With Huawei being at the forefront of this next round of tariffs, it they will most certainly target more electronics and that could certainly hurt more of the goods that Best Buy sells. These recent developments could certainly cause Best Buy to lower their guidance for the rest of the year.

Our Software Generated an Escalated Risk Alert on April 26

The Smartstops software generated its second elevated risk alert for the past nine months on April 26. The first alert came back at the end of August when the stock was trading at $77.99 and the stock proceeded to fall down below the $50 level. The software then recognized a move back to normal risk levels on February 5 and that remained the case until the most recent alert.

BBY SS Alerts.jpg

(source: SmartStops.net)

The elevated risk alert last August came as Best Buy’s stock was hitting overbought readings from its 10-week RSI and the weekly stochastic readings. This pattern is playing out again with the new elevated risk alert and it is happening as the stock is hitting potential resistance at the $75 area. The stock initially had trouble breaking through $75 in January ’18 and again in May.

BBY SS.png

What is really interesting is how the trend line that connected the lows from 2016 and 2017 appears to have acted as resistance in April. The trend line helped define the upward trend and the stock broke below it last November. When the stock rallied back up to the trend line it was right at the $75 area.

Another potential concern comes from the daily chart. We see that back in October, the 10-day moving average made a bearish crossover of the 50-day moving average. This bearish crossover came very early on in the selloff that took the stock down below $50. The 10-day has just crossed bearishly below the 50-day again this week. For Best Buy shareholders sake, let’s hope this isn’t setting up a replay of the fourth quarter selloff.

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Factors That Could Help Best Buy

Even with the SmartStops software pointing to elevated risk levels, there are certain factors that could help Best Buy. First, if a trade deal is worked out, that could override any negative news from the earnings report. It’s doubtful that we will get a trade deal that quickly, but you never know. Secondly, the sentiment toward Best Buy is rather bearish with far more “hold” and “sell” ratings than “buy” ratings, and the short interest ratio is above average.

When we see bearish sentiment like this, it generally means that the expectations for the stock are lower. This sentiment can shift from bearish to bullish on good news and it can help drive the stock higher.

A third factor that could help Best Buy are the oversold readings from the daily overbought/oversold indicators. We could see a short-term pop in the stock and that could move it back above the $70 mark, but it will take more than a little pop to move the stock through the resistance at the $75 level.

The Overall Outlook for Best Buy

The elevated risk alert is obviously a concern, especially based on how well the previous alert would have protected investors from a major decline. The technical picture is also a concern, the way the pattern is looking very similar to last September/October time frame.

The fundamental picture isn’t bad, but it is also a little muddled because of the trade war. Best Buy made forecasts based on one tariff rate and that rate just got raised. Because of the short time frame between the tariff hike and the earnings report, the company might not lower guidance yet, but the guidance could certainly be lowered in the near future if an agreement between China and the U.S. isn’t reached.

The sentiment toward Best Buy is actually encouraging. The stock has pretty much moved with the market over the past year, but investors aren’t overly optimistic about it. If we see analysts becoming more bullish and issuing upgrades, that can help the stock. If the stock moves above the $75 level and the short sellers haven’t covered yet, the short covering could help push shares higher.

For the risk level to adjust back down to normal the stock is going to need to break above the $75 level or it is going to have to fall further and then start stabilizing.

If you own the stock, a drop back down to the $50 area could be hard to take. The June and July puts that could serve as insurance against another big decline are pretty expensive right now—the June 70-strike puts are priced at $4.35 right now and they are only $1.50 in the money. Of course if the stock were to fall down to $60 within the next month, they would be well worth it.

Best Buy is a favorite of dividend investors and with good reason. The company has increased its dividend for 10 consecutive years. However, you need to keep in mind that owning 1,000 shares generates $500 per quarter at the current dividend rate. The benefit of the quarterly dividend can be erased with a drop of only 1%. With the stock trading right at $70, a 1% decline generates a reduced value of $700 if you own 1000 shares. A drop of 10% generates a reduced value of $7,000. Is the $500 in dividend payouts really worth holding through a prolonged downturn?

If you are looking to buy shares of Best Buy, we suggest waiting until the risk level returns to normal.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.