Best Buy (BBY): ‘Inflation’ Won’t Save It Forever

Best Buy (NYSE:BBY) has been and is expected to continue and be, a beneficiary of the so-called inflation phenomenon we’ve been experiencing in the United States and around the world since the COVID-19 pandemic hit the global economy. It’s true that the pandemic shut down a whole slew of industries as demand decreased, and then once the pandemic lockdowns and shutdowns ceased it was hard for these industries to meet the rising demand. However, since then what we’ve been seeing is that companies like Best Buy are using inflation talks in other industries as an excuse to raise prices on consumers and reap the rewards, as we continue to see gross profit growth far exceed that of revenue growth, indicating a combination of lower cost of goods and higher overall prices.

That’s what Best Buy has been doing and it’s what analysts expect them to continue and do over the next 3 years, as evident by the numbers:

• The company’s revenues increased by 9.5% from 2020 to 2021, rising from $47.3 billion to $51.8 billion, while their profits increased by 16.4% from $2.6 billion to just over $3 billion – even while their SG&A expenses (selling, general and administrative) rose from $8 billion to $8.6 billion.
• After 2023, where analysts expect the company to report a slight decline in both revenues and earnings, the company’s revenues are expected to grow by 2.1% and 2.6% in 2024 and 2025, respectively, while their net income is expected to grow by 13.7% and 19.1% for the same time period, respectively, indicative of the company continuing to raise prices.

Both of these data points show that the company is relying on these price increases and continued high “inflation” to justify their growth and thus – valuation. However, I am not convinced that these price increases are here to stay and that with the more recent messaging by worldwide leaders about the cause of inflation and increased executive compensation and other metrics – the public is beginning to notice these increases as part of a corporate greed scheme and not as much as a result of the COVID-19 pandemic difficulties.

For that reason, I believe that the company’s profit increases are going to resemble their revenue increase projections, perhaps a tad more, and not the clear outperformance as I’ve mentioned earlier in the article.

I’ll get into the numbers later in the article but for now – there are still positive factors for Best Buy, even if earnings per share figures, I believe, are going to be quite lower for 2023 and 2024 than current projections.

Positive Factors To Consider

The company is expected, after all, to report rising revenues in 2023 and 2024, which is quite good considering they’re a mostly retail company selling from physical stores, for the most part. This overall increase, even as low as it is, is indicative of the company’s superior business model and customer service expertise which tends to bring in new customers as well as old ones for repeat purchases in all things technology products.

Another positive is that the company has been working on reducing its interest expense it pays on its debt, which decreased from over $100 million annually about 5 years ago to just over $25 million each year, which is easily affordable for Best Buy even if revenues and income decline for any period of time.

Saving the best for last – Best Buy has a sustainable and high-yield dividend. As it rakes in about $7.00 per share in normalized earnings ($9.84 in diluted earnings) it paid out $2.98 per share in annual dividend, which was just raised to an equivalent of $3.52 per share. This comes out to a yield of over 4.1%, more than double that of the S&P 500 Index (SPY) of just 1.52%.

This makes Best Buy a good long term compounding performer by default, even if you don’t expect the company to move much each year from a price action point of view.

Dividend Is Sustainable, But For How Long?

Best Buy has consistently kept their dividend payout ratio at around 30% of earnings per share. However, with their most recent increase and a forecasted decline in profits for the upcoming year, the company’s payout ratio is set to increase to just shy of 40%.

I believe that there are 2 scenarios worth considering:

The first is that earnings do indeed grow at the level which analysts currently expect them to and the company reports solid growth in earnings on the back of price increase. This means that the company is only set to reach its 30% payout ratio around 2024 where earnings of $11.61 per share will represent the desired and historical payout ratio.

Given that part of Best Buy’s business model requires more cash investment in retail stores, updated selling platforms and increased marketing to get the word out about various deals and customer service initiatives, it required more cash. This means that although a payout ratio of 40% is not all that bad for them, any significant decline in earnings and the fact that many investors are in Best Buy’s stock for the yield, any dividend rate cut can cause an outsized decline in share price.

The second scenario is if, as I mentioned earlier, the company reports earnings growth more similar to their projected revenue growth due to their inability to continue and raise prices on consumers without a resulting decline in business. This means that instead of a 13.7% and 19.1% earnings per share increase in 2023 and 2024, respectively, we see a 2% and 2.6% increase for the respective period:

Year	EPS	Dividend	Payout
2021	$9.84	$2.98	30.3%
2022*	$9.26	$3.52	38.0%
2023*	$9.45	$3.52	37.2%
2024*	$9.69	$3.52	36.3%
2025*	$10.31	$3.52	34.1%

(Source: Author Earnings Projection, based on analyst expectations)

*Projected figures

Conclusion – Not As Glamorous

Best Buy is certainly a solid company with decent growth prospects, right now.

But given that we are continuing to see more and more business shift online and centralizing towards companies like Amazon (AMZN) and others, it’s hard to see the company report anything but the low single digit revenue growth for the foreseeable future. As price increases caused profits to increase at a significantly higher rate, valuation has been inflated, in my opinion, to a point where a new investment is not the wisest thing at this price point.

Given the aforementioned earning per share figures, the company is currently trading at around 8x to 9x forward earnings, placing them in-line with other companies which have a heavy retail “brick-and-mortar” presence. This is why I believe the company is fairly valued.

However – given the fact that current profit projections, even after 17 downward revisions in the past 90 days, remain high and reliant on continued price increases, I believe that the company is going to miss profit projections as they currently stand, forcing valuation to take a slight hit – thus representing a bad investment.

With a yield of over 4% and an expected profit increase of around 2% annually, an investment from earlier in the price action cycle might be wise but I continue to believe that there are far superior investment opportunities elsewhere and I’ll cover those in the coming weeks.