Best Buy Stock: A Stable Business, But Risks Exist (NYSE:BBY)

We enjoy looking at retail sector stocks despite them being in a highly competitive space. One company with a strong brand name that jumps out at us is Best Buy Co Inc (NYSE:BBY) with an impressive dividend yield of 4.38% at the moment. The dividend strength just can’t be ignored in the case of an innovative company like Best Buy, but despite all of this, we are going to rate the stock as a hold.

In today’s day and age, technology is a necessity. We were curious to see how businesses that offer necessities were faring. Additionally, Best Buy should have good margins on its products in comparison to grocery stores. Best Buy is renowned for its superior customer service and tech know-how which should give it the edge in charging comparatively higher prices.

What To Like About Best Buy

The dividend yield was what caught our eye. In fiscal 2022, $4.2 billion was returned to shareholders through dividends and share buybacks. The dividend growth has been quite amazing as it has been eight consecutive years of at least 10% growth in the dividend payment (BBY Annual Report FY 2022, Pg:6).

Technology will continue to be something people need. There is the metaverse and now green electricity which fuels the need for tech.

The economies of scale are hard to measure, but it is a huge moat in our opinion.

It is good to see that the consumer electronics store has no long-term contracts with their vendors. This sort of flexibility is key to efficient inventory management. Inventory levels appear to be well managed with an eye on consumer demand (BBY Annual Report FY 2022, Pg:17).

What Not To Like

Retail stocks have trended downwards in the last couple of months. Additionally, the seasonality of the business means that it can be tough to weather the hard times for investors. After all, the fourth quarter represents a large proportion of the revenues earned (BBY Annual Report FY 2022, Pg:17).

Best Buy’s Business Summed Up In Our Words: People First, Strategy First and Environment First

Best Buy anticipates the digital business to increase significantly with the pandemic accelerating this trend. The firm is ready for this change as exemplified by the fact that the percent of online orders they delivered in a single day was twice as high as pre-pandemic levels. The online revenue has shot up 115% compared to two years ago (BBY Annual Report FY 2022, Pg:4).

Let’s delve into what makes Best Buy attractive, before looking at the downside risks. It is the People First drive, Strategy First acquisitions and Environment First projects that give Best Buy an edge in the eyes of investors like us on top of its recognized brand and sales growth among other things. There will be a small discussion in turn on the risks chiefly to the balance sheet for each of these three rosy initiatives.

People First

Best Buy has invested more than $400 million in enhanced employee benefits over the past two years. All of these investments have borne fruit as can be seen in the lower staff turnover rates. The field turnover rates are much below the retail average. Moreover, the store general manager turnover is only 6 percent (BBY Annual Report FY 2022, Pg:5).

Best Buy has invested heavily in its people and this is the reason for its digital business success. The company is paying its people more with the average wage rate rising 20% in the last two years because the minimum wage was raised to $15 an hour and there was a shift of staff into higher-skilled and higher-paying positions. In fact, the average wage of Best Buy’s field employees is currently more than $18 an hour. Additionally, in 2020, the flexible workforce initiative saw to it that 80% of the company’s talented Retail Store associates were up skilled to take on multiple jobs inside the stores, offering them the chance to get new skills and advance their careers. This has the effect of creating a remarkable customer experience (BBY FY 2022 Annual Report, Pg:4).

The company’s cash generation is negative and it has gotten into this territory in the past couple of years. Excessive borrowing may be a concern. On the plus side, the debt levels have reduced over the last year and the nice thing to note is that the firm is holding $1.75 billion in net cash. However, zooming in on the balance sheet shows that there are liabilities of $10.7 billion due within 12 months and a further $3.81 billion due over an extended timeframe. So all these freebies are not going to be great for the balance sheet going forward.

Strategy First

Best Buy pays its staff well so that it can pursue growth opportunities. Healthcare is something that CEO Corie Barry has frequently stated is one of these growth opportunities. After acquiring GreatCall in an $800 million deal in 2018, it has acquired the Scottish medtech Current Health for $400 million in late 2021 to provide assets that it calls critical to the execution of its long-term strategy.

Another related acquisition was that of Yardbird for $85 million. Yardbird specializes in premium patio sets made of sustainable materials including recycled plastics. There was a huge increase in demand for Yardbird’s products in the early days of the pandemic lockdown and this interest has continued.

Investors may wonder whether these significant acquisitions were necessary in the first place. Wall Street likes to see strong balance sheets and it may have been a better decision to simply shore up the balance sheet by using this money to pay down debt.

Environment First

Best Buy is delivering long-term shareholder value by investing in the environment. Clean energy is important to the company with four solar energy projects that are predicted to generate about 1.5 million megawatt hours of clean electricity every year.

Best Buy stands to help its customers make some substantial energy savings by using ENERGY STAR certified products. The energy savings are expected to be in the ballpark of $5 billion. The firm is committed to step up its recycling efforts and boasts of over 2 million items being recycled through Trade-In, Geek Squad repair and Best Buy stores. Recycling is a great way to boost profitability (BBY Annual Report FY 2022, Pg:9).

The consumer-electronics chain has committed itself to reduce its carbon footprint and the inclusion in Fortune’s list of the World’s Most Admired Companies shows that its efforts are being recognized.

Sustainability is a cornerstone for Best Buy and it made Barron’s Top 5 for the fifth year in a row of the most sustainable companies.

Sustainability and waste reduction are key themes in the annual report. There are some more figures to wrap your head around like the fact that the company has collected more than 2.5 billion pounds of electronics and appliances for recycling since 2009, including more than 192 million pounds in 2021 (BBY Annual Report FY 2022, Pg:18).

These admirable efforts do come with costs attached. Nonetheless, the savings and long-term cost reductions will mean that there is less risk to the balance sheet in coming years.

Financial Position

The financials are quite weak for Best Buy and is the biggest reason that we recommend to hold the stock. A glance at the financial highlights shows consistent growth in the topline. The stock price over the years has also shown a similar healthy trendline. Additionally, EPS is growing steadily every year since 2018.

Free Cash Flow is a big plus for Best Buy as it generated over $6.5 billion in the past two years (BBY Annual Report FY 2022, Pg:6). The Consumer-electronics chain has a fairly good FCF yield too coming in at 12.62%.

However, the electronics retailer has a net margin that is not impressive at 3.23%. What is more, the net margin is declining reflecting the trend of most companies facing margin compression. This metric leaves a lot to be desired.

Best Buy has experienced some good revenue growth over the last couple of years. Best Buy annual revenue for 2022 was $51.761B, a 9.52% increase from 2021. Best Buy annual revenue for 2021 was $47.262B, an 8.3% increase from 2020.

Best Buy’s current ratio has been hovering at just under 1 for 2022. This is slightly alarming to see and shows that the electronics giant doesn’t have enough liquid assets to cover its short-term liabilities. Keep in mind that a good current ratio value lies anywhere between 1.2 to 2.

A glance at the price/book historical data shows that company has been recording ratios just above 5 in the last three years. Consequently, these high multiples mean that Best Buy stock is rather expensive at the current valuation.

Risks

Unemployment rates, consumer discretionary spending and consumer confidence could worsen. Customer traffic will also reduce which may negatively impact profitability. There will be balance sheet ramifications when some of the stores do not generate enough revenue to cover operating expenses. The non-cash impairment charges recorded will go up as the value of the owned and leased properties are adversely affected. Additionally, debt may rise as the company looks to finance itself during the downturn. The financial condition and liquidity of the firm could be aggravated.

With less money on hand, consumers might upgrade or replace their devices less frequently. It must be taken into account that the computer and mobile phones product category has the highest contribution to the company’s sales as of Q2 2022. So investors can see the dependence of the electronics chain on this one product category that is very susceptible to consumers’ incomes. There will be an increased likelihood of opting for inexpensive brands and products. Furthermore, a reduced appetite for complementary services such as extended warranty plans has been seen during previous recessions.

There are a whole host of macroeconomic factors including but not limited to real GDP growth, interest rates and housing market conditions that crop up as risks.

A word on the Mexico store closures

It is fascinating to note that BBY stock has been on a downward trend since it announced that it would close its 41 stores in Mexico in late 2020. Shares fell sharply too at the announcement itself. The economies of scale advantage enjoyed by the chain through its global vendor partnerships may have taken a slight hit evidently.

Big Rebound in 2023?

There is a good possibility of a big rebound in sales as the year comes to a close in 2023. Recessions don’t last too long in the United States with the exception of the aptly named “Great Recession” of 2007-2009. Best Buy has reported that it has seen upward spikes in sales of certain products towards the latter stages of the pandemic. Consumer electronics sales had kept ahead of other sectors during recessions. A key takeaway from the BBY annual report was that consumer spending on consumer electronics was higher during the pandemic when compared to pre-pandemic levels. In addition, certain products and services have seen increased demand during the pandemic. This resiliency of BBY’s biggest product category as measured by sales demonstrates that earnings may get a boost as the US economy emerges out of the recession.

Conclusion – Q4 2023 Earnings Will Determine If We Change Our View On The Stock

Let’s get this out of the way. We love the business and it does satisfy a very important need for US and Canadian consumers. But the financial position is weak and the price tag is rather expensive even after all the stock declines since the closure of the Mexican business. Even with the advantage of product stickiness that Best Buy appears to enjoy, we would like to see how earnings go in 2023 before we look to own this stock.

Material sourced from Best Buy Fiscal 2022 Annual Report.