Best Buy: An Updated View (NYSE:BBY)

This year we have already published two articles on Best Buy (NYSE: BBY), titled:

Both times We have given Best Buy a Hold rating. The main reasons for our rating were:

+ According to traditional price multiples, BBY appears to be undervalued.

+ The company has a strong track record of returning value to its shareholders through dividend payments and share buybacks.

– Macroeconomic headwinds are likely to put pressure on sales and margins in the near term.

– Best Buy’s comparable company sales are declining.

In today’s article, we will revisit Best Buy and provide an updated view of the stock, taking into account the latest macro and microeconomic developments.

Let’s start with the company’s latest quarterly report.

Quarterly earnings report

As in the first quarter, comparable sales figures continued to fall in the second quarter.

Sales trended downwards in all segments along with falling margins. While these results aren’t particularly encouraging for shareholders, they’re not surprising. We highlighted in our previous article that low consumer confidence is likely to lead to falling demand for durable non-essential goods. This trend is now clearly reflected in the company’s results. In the press release, management also addresses the weaker than expected demand compared to previous years:

Our comparable sales declined 12.1% as we posted strong comparable sales growth of 19.6% last year. […] At the start of the year, we expected the consumer electronics industry to be weaker than last year after two years of elevated growth, driven by unusually strong demand for technology products and services and driven in part by stimulus dollars. The macroeconomic environment has been challenged by a number of factors, which is putting additional pressure on our industry.

On the other hand, the company has kept its most recent guidance (released in July) unchanged, calling for a comparable revenue decline of the order of approximately 11% and a non-GAAP operating income rate of approximately 4%.

On a segment basis, further information was provided on the driving factors for declining sales and declining margins:

Domestic

From a merchandising perspective, the company saw comparable sales declines in almost every category, with the biggest drivers on a weighted basis being computers and home theater. The domestic gross profit rate was 22.0% compared to 23.7% a year earlier. The lower gross profit rate was primarily due to: (1) lower margin rates for services, including pressures related to Best Buy Totaltech’s membership offering; (2) lower product margin rates, including increased promotions; and (3) higher supply chain costs.

All of the reasons given here were partially anticipated in our first two articles.

International

International sales of $760 million declined 9.3% year over year. This decrease was primarily due to a comparable sales decrease of 4.2% in Canada and the negative impact of approximately 420 basis points from foreign exchange. The international gross profit rate was 23.4% compared to 24.3% in the previous year. The lower gross profit rate was mainly caused by lower product margin rates.

Not only Best Buy, but many internationally active companies have experienced significant currency exchange headwinds in recent quarters due to the historically strong USD against other currencies. Due to rising interest rates in the United States, we expect this trend to continue in the near term and continue to negatively impact BBY’s overseas financial performance.

Giving value back to shareholders

Best Buy has shown a strong commitment over the past 18 years to returning value to its shareholders in the form of dividend payments. On August 31, the company announced that its board of directors had approved a quarterly dividend of $0.88 per share, in line with the previous amount. This amount corresponds to a forward yield of approx. 4.7%.

On the other hand, the company paused share buybacks in the second quarter of fiscal 23. While we’ve previously stated that we like companies buying back their shares, we understand the reason for the current decision. In our view, in the current challenging macroeconomic environment, it is important for the company to adjust its capital allocation priorities to ensure it has sufficient financial flexibility should headwinds persist for longer than anticipated.

valuation

In our previous articles, we mentioned that we find BBY stock attractive from a valuation perspective.

Since then, the stock price has fallen about 5%, roughly in line with the broader market’s decline. Despite the decline in earnings, we believe BBY stock remains attractive at this price level. Most valuation metrics show that the company is still trading at a discount to its 5-year moving average and the median of the consumer discretionary sector.

The central theses

The macroeconomic environment has not improved significantly. Low consumer confidence, declining demand, supply chain disruptions, increased input and freight costs continue to negatively impact Best Buy’s financial performance. We believe these headwinds are temporary but likely to continue for the remainder of the year, possibly into mid-2023.

Despite the relatively sharp decline in sales and declining margins, management has not changed its previous full-year guidance from July.

Although BBY suspended its share buyback program for understandable reasons, they continue to pay quarterly dividends to their shareholders.

From a valuation perspective, we still think BBY is attractive.

For these reasons, we maintain our “Hold” rating on the stock.