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Best Buy: Three Metrics To Gauge A Turnaround

Best Buy: Three Metrics To Gauge A Turnaround
By: Nancy Kross
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Best Buy Company Inc. (BBY), the nation’s largest electronics retailer, is down almost 40% this year, after having registered a remarkable surge of 236% in 2013. Hubert Joly, the French veteran who took over as CEO in 2012, outlined a well-devised strategy called “Renew Blue,” named after blue t-shirts worn by the firm’s sales associates. Investors became optimistic with the introduction of the turnaround plan; however, sentiments failed to sustain and turned the other way when the company posted a decline in sales during the holiday season, which happens to be the most crucial season for retailers.

Bidness Etc is convinced of Joly’s strategy and can foresee a turnaround in the coming future. However, for purposes of clarity, we recommend our readers to look out for the following indicators to gauge Best Buy’s progress.

Improvement In Margins

Joly, who believed in eliminating price as an obstacle to conversion, came up with a price-matching policy to attract customers. His strategy was simple: customers should not leave the premises just because they could get the same products at a cheaper price from some other retailer. This strategy, however, weighed heavily on margins. In 4QFY14, gross margins declined the most to 20.1% as the company relied on sharp markdowns to lure customers. During the earnings call, the management said the price-matching policy helped increase its market share, but that came at a cost. The company perhaps did not have a choice because the overall retail environment was intensely promotional.

Although the company has managed to show signs of improvement in operating and profit margins by rolling out various cost-cutting measures, signs of improvements are yet to be seen in gross margins. The company exceeded its target of saving $725 million by $40 million, and has also raised the annual cost-saving target to $1 billion for this year. Despite the fact that saving operating costs would enable the company to expand its bottom line, we feel improving gross margins is extremely important and is a measure of sustainable growth. In the last five years, the highest annual gross margin of 25.1% was achieved by the company in FY11. We believe once the company starts showing improvement in its gross margins, optimism for a turnaround will certainly gain momentum.

Increase In Same Store Sales

In addition to a price-competitive policy, the company has initiated various strategies to lift its sales, including investments in e-commerce channels and collaboration with various vendors.

The Minnesota-based electronic retailer has made substantial investments in its online channel to counter competition from online retailers like Amazon.com Inc (AMZN). Best Buy upgraded its website and rolled out the “buy online, ship from store” and “buy online, pick up in store” options for its customers.

Likewise, the company has brought Sony Corp (SNE) and Samsung Electronics Company Ltd. (SSNLF) on board after having collaborated with Google Inc. (GOOG), Microsoft Corp. (MSFT), and Apple Inc. (AAPL). This year, Best Buy plans to open 350 and 500 shop-in-shops under Sony and Samsung, respectively. The initiative would not just enhance visual display of merchandize, but the physical store will also serve better by giving advice and guidance to customers on selection and usage of products.

Although these strategies have helped Best Buy’s overall sales, same store sales, the most crucial metric used to gauge the health of a retailer, has not shown consistent growth. The company did report a smaller year-over-year decline in the metric during the last four quarters, but positive growth was demonstrated in 3QFY14 only. We believe that once the electronic giant consistently starts posting growth in its comparable sales, a turnaround will become inevitable.

Sales Tax On E-commerce Operators

Though Joly has outlined a pretty impressive strategy to trigger the company’s turnaround, one thing that is hampering recovery is sales tax exemptions that give online retailers a competitive advantage. Out of 52 states in the US, Amazon collects sales tax in 21 states only, indicating that the e-commerce giant can offer products at lower prices in comparison to traditional retailers. According to a research conducted by Ohio State University, Amazonlost about 9.5% in revenues in the 21 states as customers turned to other online retailers that did not collect taxes. We believe that once the sales tax is imposed on all e-commerce retailers, the undue price advantage enjoyed by a few would cease to exist and retailers with a physical presence like Best Buy will get a chance to compete on an equal footing.

Our Advice

Best Buy, which is due to announce its first-quarter results on Thursday, is expected to report earnings of 19 cents and revenues of $9.22 billion. This would translate into a decline of almost 40% and 2% in earnings and revenues, respectively. We do not expect to see improvement in the metrics discussed above anytime soon. In fact, we would recommend investors not to take first-quarter results as a yardstick to measure the company’s turnaround since the preceding quarter was a difficult one for the overall retail industry owing to harsh weather conditions.

As regards to analysts’ ratings, 15 out of 27 analysts covering the stock rate it a Buy, while 11 recommend holding onto the stock. The consensus target price given by these analysts is $33, which translates into an upside of 31%.

Also read our in-depth analysis on why Best Buy can still witness a turnaround.

What do you think about our views on Best Buy? Leave your thoughts in the comments section below, and an analyst will reply to you shortly.

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