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Best Buy Is Hit With a Holiday Downgrade

By Timothy Green - Dec 17, 2018 at 2:05PM

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Possible headwinds are piling up for the consumer electronics retailer.

Shares of consumer electronics retailer Best Buy ( BBY 0.23% ) have already lost nearly 35% of their value since peaking a few months ago, but analysts at Bank of America Merrill Lynch (BAML) see more pain ahead. They downgraded the stock on Monday and slashed their price target, citing concerns about iPhones, TVs, gaming, and a partnership between Apple and Amazon.com

The downgrade

BAML reduced its rating on Best Buy stock from neutral to underperform. This comes about a month after the investment bank knocked down its rating from buy to neutral. At that time, BAML cited concerns about freight expenses, higher labor costs, and heavy investments in the business as potential problems for the bottom line.

A Wall Street street sign.

Image source: Getty Images.

Along with the new underperform rating, BAML reduced its price target on Best Buy to just $50 per share. That's down from a previous target of $70, which itself was a reduction from a much more optimistic $92 target.

This time around, BAML sees deeper problems. Decelerating growth in TVs, Apple products, and gaming could hurt Best Buy's growth, and weak demand for iPhones in particular could hurt store traffic. A variety of guidance cuts from Apple suppliers suggests that the latest iPhones aren't selling all that well.

Another issue is a deal between Apple and Amazon to bring more official Apple product offerings to the e-commerce site. Under the agreement, third-party resellers without Apple's authorization won't be allowed to sell Apple products on the site after Jan. 4, and the assortment of available Apple products will be expanded. This deal could hurt Best Buy's sales, although it won't take effect until after the holidays.

Best Buy's own guidance for the fourth quarter calls for comparable-store sales growth between 0% and 3%, a weak outlook compared with the 4% to 5% growth the company expects for the full year. Best Buy has the tendency to give conservative guidance, so it may be able to put up better numbers. But BAML sees a chance of Best Buy falling short of its guidance, and it warns that the consensus earnings estimates for this year and next are too high.

Best Buy expects full-year non-GAAP earnings per share between $5.09 and $5.19, and analysts see fiscal 2020 non-GAAP EPS of $5.51 on average.

Should investors care?

Analyst upgrades and downgrades are mostly noise, especially for long-term investors. But BAML does raise some legitimate concerns. Best Buy depends on popular product launches to drive traffic and sales. Slumping demand for the latest batch of iPhones could not only reduce smartphone sales, but also sales of related products.

TVs could also eventually become a problem. Consumers don't upgrade their TVs all that often on average, certainly far less frequently than smartphones. Affordable 4K smart TVs have been driving a replacement cycle, but that cycle will eventually end. OLED TVs may start a new cycle, but prices are still too high for mass adoption.

Add it all up, and slowing growth for Best Buy over the next few years seems likely. However, the company is betting on services to keep sales growing. Best Buy acquired GreatCall, the company behind the Jitterbug smartphone and associated subscription services, for $800 million this year. It has also rolled out offerings like Total Tech Support, a subscription service aimed at providing all-encompassing tech support to its customers. This move toward subscription services could help Best Buy become less sensitive to consumer electronics product cycles.

BAML's new $50 price target, which is a few dollars below the current stock price, is quite pessimistic. If Best Buy stock were to fall to that price, it would trade for less than 10 times the company's fiscal 2019 non-GAAP earnings guidance. There's always the chance that Best Buy's earnings get pushed down next year by the various headwinds facing the company. And if there's a recession anytime soon, earnings could take a big hit.

But Best Buy is one of the best-run retailers around. The company has become dramatically leaner and more efficient over the course of its turnaround, and it has found a way to thrive despite intense competition from online retailers. For long-term investors, Best Buy looks like a great buy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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