Is Best Buy Ready to Buy Back Shares?

During Best Buy's (NYSE: BBY  ) most recent conference call, an analyst asked CFO Sharon McCollam about the possibility of share buybacks. McCollam replied:

We're going to continue to evaluate our cash balance, obviously. [CEO] Hubert [Joly] and I believe deeply that putting a fortress on this balance sheet is really important. Obviously we know what bumps in the road look like, but we also know that over time there is a level of cash that makes sense and is a fortress and then there's the time when you exceed that. At this point, we are very comfortable with where we're sitting on our balance sheet and we'll be talking about this over the next 12 months. But at this time, we do not have any plans on a share buyback.

Best Buy's history of share buybacks is dismal, with the company spending large amounts of cash during times when the stock price was high and shunning buybacks completely when the stock price was low. But with a new management team in place and a strong balance sheet, is Best Buy ready to start repurchasing shares?

Two conditions
A company should only repurchase shares when two conditions are met. First, the stock should be undervalued; and second, the company needs to have ample cash available beyond its operational needs.

Looking at Best Buy's history, it's clear that the previous management bought when the stock price was high and abstained when the stock price was low. Leading up to the financial crisis, Best Buy spent $3.5 billion on buybacks when the stock price was near $50 per share. But when the price fell to around half that value, the company stopped buying shares completely for two years... until the price had largely recovered.

Best Buy also violated the second condition, with the buyback program in fiscal 2011 and 2012 jeopardizing the financial stability of the company. By the time Joly took over in August 2012, the balance sheet was not in great shape.

Joly has quickly turned the situation around, using the company's free cash flow along with the sale of Best Buy's European operation to build up a $2.9 billion pile of cash; covering the company's debts and then some. Now the stock is trading at historically low levels, down significantly from just a few months ago. And with the company's coffers brimming with cash, I suspect we'll see Best Buy begin buying back shares later this year. Hopefully, Joly will be more tactical than the previous management team.

Wait. Aren't things still bad at Best Buy?
If you only read the headlines, then you know that Best Buy suffered a decline in comparable-store sales during the holiday season, an event that sent the stock price tumbling. How can a retailer with declining sales afford to buy back shares? Well, because Best Buy is still very profitable.

In fiscal 2014, the adjusted net income, where I've added back restructuring charges and charges related to the sale of Best Buy Europe, was more than $900 million. This was during a supposedly terrible year; it's clear that, even after the $233 million in dividend payments, Best Buy has plenty of room to buy back shares without hurting the balance sheet.

There's even reason to believe that things will improve for the retailer this year. Further cost-cutting will help profitability, and the explosion of store closings by competitors will have the effect of pushing more business to Best Buy.

RadioShack (NYSE: RSH  ) , which has shifted its focus to selling mobile phones and phone plans in recent years, announced earlier this year that it would be closing more than 1,000 of its small-format stores, reducing its store count by around 20%. RadioShack had an abysmal holiday quarter, and I suspect that we'll see the rest of those stores close sooner rather than later. With Best Buy being one of the major sellers of mobile phones in the United States, less competition should allow the company to grow its market share even more.

Sony also recently announced some store closings, with a plan to shutter 20 of its 31 U.S. retail stores. With companies like Microsoft, Samsung, and Apple having a mini-store presence inside of Best Buy locations, Sony could be the next company to embrace the store-within-a-store concept. As it becomes more difficult for smaller consumer-electronics retailers to compete, Best Buy has the opportunity to claim a larger portion of the consumer-electronics pie.

Best Buy has more of a perception problem than an operational problem, and it's easy to simply assume that the company will be destroyed by online retailers. But Best Buy is in a strong position financially, and it's rapidly growing its online business in order to remain relevant with today's consumer.

What's more, Best Buy now ships online orders from all of its stores, speeding up shipping times and greatly improving inventory availability. Along with the ability to pick up online orders directly from the store, often in the same day if the item is in stock, Best Buy's goal is to simply offer its customers as many options as possible. This differentiates Best Buy from online-only competitors, and it gives the company an important competitive advantage.

The bottom line
Best Buy is now in the financial position to seriously consider restarting its share-buyback program, although the mistakes of the past need to be avoided. The balance sheet is strong and the company is profitable, and there are many reasons to believe that the situation will get even better for Best Buy as time goes on.

I suspect that Best Buy will announce a modest share-buyback program sometime this year, perhaps even increasing its dividend. And with the stock trading at a discount, shareholders should be thrilled.

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