Best Buy Is Facing Too Many Headwinds

Best Buy's (NYSE: BBY  ) stock has appreciated 188% year-to-date. You might be upset you missed it, but this meteoric ascent likely had a lot more to do with the broader stock market's rise than Best Buy's real-world performance. Now we must look at what the future holds for this once-dominant consumer electronics retailer.

External factors

By selling products and services primarily related to electronics, Best Buy relies heavily on consumers' discretionary spending. Therefore, many external factors play an important role. For instance, if unemployment is low, the stock market is in bull-mode, and if real estate is improving, then Best Buy is more likely to see growth.

While unemployment isn't low at the moment, it has been improving. And stocks and the real estate market have been hot. On the other hand, one must look towards the future in order to make money in stocks. And based on historical trends, interest rates can't remain low forever. When interest rates eventually increase, it will negatively impact stocks and real estate. This, in turn, will affect consumer spending, as well as Best Buy's potential. Furthermore, while unemployment is lower than before, it's a deceptive reading. More people are employed, but lower wages are a big issue.

All of the above factors are concerning, and they're on top of a 2% payroll tax increase, as well as rising gas prices.

Company goals and cost-cutting measures

Best Buy's ultimate goals are revenue growth and disciplined capital allocation. To get there, it aims to offer all of the latest and most popular devices in one place (as well as online) at competitive prices, and it wants to offer knowledgeable advice via its Geek Squad service.

Best Buy is also cutting back on its large-format stores and opening more Best Buy Mobile stand-alone stores. For instance, the total store count in Q1 FY 2013 was 1,103, and that dropped to 1,056 in Q1 FY 2014. However, the Best Buy Mobile stand-alone store count totaled 326 in Q1 FY 2013, versus 409 in Q1 FY 2014. This trend should help cut costs and potentially improve the bottom line; but due to smaller square footage and a limited category focus, it won't help the top line.

Best Buy has made several other moves to reduce costs, such as negotiating reduced rent for some stores, eliminating $175 million in selling, general and administrative (SG&A) and supply-chain costs, and entering an agreement to sell a 50% interest in Best Buy Europe to Carphone Warehouse for $500 million. 

Fierce competition

Amazon (NASDAQ: AMZN  ) , a market-share stealing machine, victimized Best Buy with ease. Amazon.com is the largest online retailer in the world, and with more people looking for convenience, the company's growth has been phenomenal. It's a low-margin operation, but CEO Jeff Bezos isn't focused on that. Instead, he wants to roll over as many competitors as possible while increasing Amazon's brand recognition. 

Best Buy is attempting to fight back in a technological sense. Best Buy will never have as large of an online presence as Amazon, but domestic online comps did jump 10.5% in the second quarter, which is a good sign.

It should be noted that both Best Buy and Amazon have trouble delivering profits. Best Buy and Amazon were in the red in three of the last four quarters and two of the last four quarters, respectively. However, Amazon is a sensational top-line performer, whereas Best Buy is downsizing. That said, it should be noted that Amazon is trading at 102 forward earnings, and while it's likely to be a quality long-term play, expectations are too high for a recommendation here -- especially with the absence of consistent profits.

Most consistent company 

Wal-Mart (NYSE: WMT  ) is another threat to Best Buy. But competition isn't the most important angle here--what's more important is that Wal-Mart recently missed expectations and guided lower for the year, citing a weak consumer across all markets.

This news is concerning because, when combined with a similar report and comments from Macy's one day earlier, it potentially indicates that the economy isn't recovering and that the consumer is perhaps weaker than most people anticipated. If that's the case, then Best Buy is likely to see trouble ahead. Wal-Mart and Macy's are two of the best-managed retailers in the world. If they're both reporting trouble, then it's more likely due to the economic environment as opposed to their individual operations. 

For the record, Wal-Mart is the most consistent company mentioned in this article. Profits are commonplace, and its net margin of 3.6 might not be high, but it's still higher than Best Buy at (1.5%), and Amazon at (0.1%).

Wal-Mart also turns more investment dollars into profit, sporting a return on equity (ROE) of 23.6%, versus (13.5%) for Best Buy, and (1.2%) for Amazon. Furthermore, Wal-Mart yields 2.4%, whereas Best Buy yields 2.2%, and Amazon offers no yield. The ultimate point here:  Wal-Mart is likely to be the best long-term investment of the group. 

Conclusion

Best Buy has potential to improve its business and see stock appreciation over the short to medium term, but with big retailers strongly hinting at weaker-than-expected consumers, and industry trends favoring deeper-pocketed rivals, Best Buy should only be looked at as a speculative trade and not as a long-term investment. 

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.



Read/Post Comments (3) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2013, at 5:45 PM, mistacy wrote:

    With Schulze selling his stake, 70M shares equal an average of 600,000 shares sold per day between October & March. That is close to 10% of the daily trading volume for BBY. This could completely change the trading trend that BBY has enjoyed this year.

  • Report this Comment On August 28, 2013, at 6:50 PM, TheBargainBin wrote:

    Schulze is selling an "undisclosed amount of stock," not his entire stake.

  • Report this Comment On August 28, 2013, at 7:47 PM, mistacy wrote:

    "Undisclosed" isn't exclusive of "all" his shares.

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