Is Best Buy the Right Stock for Investing in Modern Retail?

Best Buy (BBY 0.20%) has revamped its in-store experience and fully integrated digital sales into its brick-and-mortar locations. That has helped the company reverse its fortunes since 2012.

In this Industry Focus discussion, the cast gives their final takes on whether Best Buy stock makes sense as a long-term value play for investors.

A full transcript follows the video.

This video was recorded on July 17, 2018.

Vincent Shen: That extra service, that high-touch service that they want to offer, they see that as a differentiator. Of course, returning to Amazon, which was mentioned in the question, Best Buy has also worked to consistently grow its online business. Their online revenue topped to $5 billion recently, and that's double the level from where it was five years ago. So, they're pushing in that realm. It's enjoying a double-digit annual growth rate, so that's not something they're neglecting. It is omnichannel.

Dan Kline: They've also done a good job with their rewards program and integrating that into their website. Their website used to be a chore. You would go, and they have a feature where you can see if something is in the store. That would work OK for new inventory. But for things like open boxes and sales and discounts, it never worked that well. They've really done a good job. At my local Best Buy, I can literally see what they have in open box inventory on televisions and things like that. They've improved that. In general, they've improved their shipping. They're not Amazon. You're not getting everything in two days, unless it's a big ticket item. But, it's improved quite a bit.

Shen: That's part of the New Blue initiative, as well. The company offers some additional guidance in terms of fiscal year 2021. They're targeting $43 billion revenue, about $2 billion of non-GAAP operating income, and ongoing operating margin around 4.5%. I think they've planned another $600 million of potential cost savings.

Ultimately, I think, with that operating margin, for example, they're running into issues where that's down from where management had previously hoped to deliver. I think they previously envisioned 5-6%. But they realize now, a symptom of the increased investments in service offerings that they're trying to roll out to develop these deeper relationships with customers, it's a worthwhile trade-off.

Some of the increased capital spending, the capital expenditures, we'll be going through things like supply chain investments, which will have its benefits go toward both its online channel and also their brick and mortar business.

Getting to Ryan's core question now, I'm curious, Dan, where do you stand on Best Buy as a long-term value play? Are you sold after doing this due diligence?

Kline: I am. I've been a fan for a few years. That said, I think Best Buy has been very good in that they're experimenting. They will walk away from things that don't work, they will double down on things that do work. This is a company that figured out, "This is where the bottom is. We can operate," they got smaller, they lost stores, they lost some people, "we can operate here if we're well-run." Now, it's, build it back up. They got rid of the small mobile stores. They refocused and put everything back together in a different way. Most retailers are great at cutting; they're not good at cutting and also trying new things.

Do I think Best Buy is going to be where it was before there was an internet? No. Do I think the company will mostly, steadily grow, with the occasional terrifying, "Christmas didn't go as well as we thought it would because people didn't buy 60 televisions."

Shen: A short-term hiccup.

Kline: Yeah. I don't think they're immune from that. Too much of their business is tied to technology answers that nobody gets 100% right, 3D televisions being a recent one, VR. There was a lot of thought that VR headsets were going to be a big deal last Christmas, and they were not.

Shen: For consumers, yeah. If you like what you've heard about New Blue, management's focus areas, some of these initiatives that they're rolling out, and the longer-term guidance that Best Buy has shared on things like revenue growth, profitability, e-commerce, there are still a few other things to consider.

Shares of Best Buy are currently trading around $75, with a forward price to earnings multiple of about 15x. With annual earnings growth over the next five years at about 8.5%, that's a price to earnings growth ratio of 1.7x. It's not quite the <1 level that typically indicates an undervalued stock, but we're talking about a more mature retail operation here. There are other parts to include in the equation.

For one, the company pays a pretty generous dividend of 2.4%. Management has guided to sticking to a 35-45% payout ratio going forward, for its dividend payout. That payout ratio is the amount of net income being paid out to shareholders. In the past few years, Best Buy has stayed within that guided range.

On top of that, though management is looking to increase its capital spend, they've also been active with their share repurchases. In the past three fiscal years, they bought back $3.7 billion of stock. That effectively reduced the outstanding share count by 20%, quite significant.

While the ongoing repurchases are going to vary going forward, the company's balance sheet is very strong. They have $2 billion in net cash. Best Buy generated $1.4 billion of free cash flow last year. So, financially, in that strong position where, you're right, they're kind of rightsizing the business, in terms of figuring out where things are. Not that they've closed a lot of locations.

Kline: No, but they've shrunk some locations. They did get rid of the mobile stores, which turned out to be very smart, because they were mostly mall-based, so they were dependent on traffic. And, cellphones have largely become a commodity, so you don't really want smartphone-only stores. That no longer makes much sense.

They're also really well-positioned to take advantage of the changes in retail. There are a lot of Toys R Us locations, there are a lot of Sears locations that are available. If you're a stable company with a good balance sheet, your ability to go to a mall operator, a Simon or whoever it is, and say, "I'm happy to go into your five new malls ... on these terms," they have the ability to do that because they're not going to go out of business in the next three years. JCPenney cannot make the same promise.