Best Buy Co Inc Has Found Its Niche – And So Has Its Stock

The biggest fears surrounding Best Buy Co Inc (NYSE:BBY) have yet to be realized. The bear case for Best Buy stock was based on the “showroom effect.” In essence, customers would view items in Best Buy stores — and then buy them from, Inc. (NASDAQ:AMZN) or eBay Inc (NASDAQ:EBAY). Best Buy’s brick-and-mortar costs would prevent it from being fully price-competitive with online-only rivals, margins would compress, and BBY stock would sink.

It hasn’t played out that way. Best Buy stock has gained more than 500% from late 2012 lows just above $10. It’s doubled just since early last year. Comparable-store sales have been positive, albeit modestly so — 0.3%, 0.5%, and 0.5% in fiscal 2017, 2016, and 2015. But they’ve accelerated so far this year, to a likely 4% or so for the full year.

It appears Best Buy has found its footing. BBY stock has done the same, gaining 32% year-to-date. But nearly all of those gains came in the first half of the year. Best Buy stock actually has pulled back modestly since I argued investors should sell the news after a post-earnings jump in May.

Even a strong performance YTD and a still-cheap valuation haven’t changed my opinion since then. There are worse stocks in the market, no doubt — and in retail, in particular. But consistent earnings growth is far from guaranteed. Looking forward, I’m not yet convinced Best Buy is quite out of the woods.

The Bull Case for Best Buy Stock

Q3 earnings certainly seem to support the argument that Best Buy stock is undervalued. Even though the headline numbers missed consensus, and Q4 guidance was a bit light, the quarter looks solid, if not outright impressive.

Comparable sales rose 4.4% year-over-year, including a 22% improvement in e-commerce sales. Adjusted EPS jumped 30%. That performance came despite modest impact from hurricanes in the quarter.

Meanwhile, BBY stock still trades at about 14x FY18 (ending January) EPS. That seems far too low for that type of growth.

But if you look closer, Best Buy’s Q3 isn’t quite as impressive. A lower tax rate provided a benefit to EPS. So did a 4.5% reduction in the share count, thanks to share buybacks. Operating income, for instance, rose a slower, but still solid, 15% year-over-year.

That’s not to say it was a bad quarter. It wasn’t, by any means. The key question is whether that type of performance will continue going forward.

The Risks To Best Buy Stock

As strong as FY18 has looked through the first three quarters, the concerns here aren’t completely erased. For one, Best Buy’s apparent status as the last major electronics retailer standing isn’t necessarily a good thing. For years, customer defections from struggling and eventually bankrupt rivals like Circuit City, hhgregg, and even RadioShack have provided a tailwind to Best Buy sales. That benefit should recede going forward.

Looking beyond competition, I see concerns about what it is, precisely, that Best Buy is selling. Best Buy floors contain a lot of challenged categories. Effective pricing is declining in the mobile space, and the intense competition among providers like Verizon Communications Inc. (NYSE:VZ), AT&T Inc. (NYSE:T), and Sprint Corp (NYSE:S) could pressure Best Buy’s commissions from smartphone contract sales.

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Sales of both desktop and laptop PCs are stalling out. TV pricing continues to come down. The steady demise of Sears Holdings Corp (NASDAQ:SHLD) has benefited Best Buy’s appliance sales: That category has been the company’s strongest over the past eleven quarters. But J C Penney Company Inc (NYSE:JCP) is now targeting that space, and Home Depot Inc (NYSE:HD) and Lowe’s Companies, Inc. (NYSE:LOW) are redoubling their own efforts.

Overall, Best Buy’s market likely isn’t growing much, if at all. In fact, it may be shrinking. Pricing power is going to be limited by online rivals. With market-share gains likely to moderate simply because Best Buy already has dominant share, those factors suggest revenue growth here is going to be pretty minimal going forward.

Best Buy Stock Looks OK – But Not A Best Buy

Modest revenue growth probably is enough to support BBY, and maybe even a little upside. Cost control can keep margins intact. Best Buy throws off a lot of cash, which can be used to buy back shares and raise a dividend that already yields 2.4%.

But that’s not really a compelling case. And the tight range in which Best Buy stock has traded since May seems to support the idea that, for now, the market thinks the stock is priced about right. At this point, I agree. Coming out of Q2, I thought the easy money had been made in Best Buy. Six months, and two earnings reports, later, I still think that’s the case.

As of this writing, Vince Martin has no positions in any securities mentioned.

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