With all the negative sentiment in the electronics retail business, how should investors evaluate Best Buy's (NYSE:BBY) recent dividend hike?
On June 10, Best Buy announced that its quarterly cash dividend would increase by 12% from $0.17 to $0.19, and this raised some eyebrows among investors.
The dividend hike certainly came as a surprise given that the retailer is still struggling with the erosion of its revenue base and a high reliance on its Renew Blue cost-savings program to deliver value for shareholders.
A company in the midst of a restructuring does not usually increase its dividend payments to shareholders. Quite often the opposite occurs: Companies undergoing profound restructurings cut back on dividend payments first as they can usually divert those cash flows the easiest.
It's about the cash, not the revenue
Sure, investors would oppose cutting or suspending the dividend, but for the sake of the survival of the company, most investors would probably be willing to go along with it.
Best Buy hiked its dividend even though the company reported a 3.3% decline in year-over-year sales and a comparable-store sales growth rate of minus 1.9% for the first quarter of fiscal 2015. In addition, a persistently low adjusted operating income margin of 2.3% and a lower gross profit margin of 22.4% compared to last year's 23.1% certainly didn't make investors cheerful.
However, while investors mostly concentrate on revenues, comparable-store sales growth and margin development, there is another side to the equation. It is true that electronics retailers continue to suffer from intense e-commerce competition. Nonetheless, Best Buy presented a variety of year-over-year improvements worth mentioning.
Improving cash position
First, Best Buy's cash and short-term investments showed a combined balance of $3.1 billion compared to last year's $908 million; this is probably the main reason that Best Buy can afford to increase its dividend without putting its turnaround at risk.
Second, Best Buy reduced its selling, general, and administrative expenses by 8% or $164 million year over year. And last but not least, Best Buy's cash flow has meaningfully improved in the last quarter and came in solidly positive at $308 million.
With a much better cash position and a cost-reduction program that seems to be yielding results, the company can indeed afford to increase its dividend payments.
Hubert Joly, Best Buy's president and chief executive officer, commented on the dividend hike: "Our decision to increase the amount of cash we are returning to shareholders is indicative of our improved cash position and our confidence in the cash-generating power of our multi-channel business model."
Hubert Joly seems to be making the right moves. For instance, Best Buy's first-quarter announcement revealed that the retailer achieved $95 million in additional annualized cost reductions, which should certainly help Best Buy's margins going forward. Joly remains focused on getting costs in check, which is about as much as the company can do now until a new turnaround plan is presented to investors.
As part of the turnaround plan, Best Buy will likely put some more emphasis on downsizing its operations. The Wall Street Journal reported last month that Best Buy intends either to seek a strategic partner for or to sell its Chinese electronics retailer franchises Five Star and Best Buy Mobile, and the transaction could be worth up to $300 million.
A sale of its China business will certainly help Best Buy in focusing on its U.S. operations, which are at the core of its franchise.
Short-term sales risks persist
While the company is still relying on cost savings and SG&A cuts to deliver value for shareholders, Best Buy still needs to come up with a road map for increasing store traffic and stopping the bleeding on the sales front.
Eroding sales are not just a problem for Best Buy. A secular demand shift to e-commerce businesses is largely to blame for the declining revenues of electronics-focused brick-and-mortar businesses.
Electronics retailer RadioShack (NASDAQOTH:RSHCQ), for instance, is also seriously struggling with low store traffic and eroding sales. In the first quarter of fiscal 2015, RadioShack reported that same-store sales were down 14% while its loss massively widened to $98 million.
The retail business is no easy business. Customers quickly punish retailers that fail to offer attractive products at competitive prices. Apparel retailer J.C. Penney (NYSE:JCP), for instance, also saw a massive erosion of its sales base throughout much of 2012 and 2013: Its revenues declined a whopping 31% over the last two fiscal years to $11.9 billion as the company alienated customers by reducing promotional activities.
Both RadioShack and J.C. Penney highlight the fact that customers can be lost quickly if dissatisfied -- and that it can be incredibly difficult to make them come back.
Although J.C. Penney reported positive comps growth of 6.2% in its most recent quarter, the company does not pay a dividend to its shareholders. Just like RadioShack, J.C. Penney used to pay quarterly dividends until 2012, but suspended payments to shareholders in order to shore up its balance sheet and fully focus on its restructuring.
Given their ongoing, difficult turnarounds, both companies are unlikely to reinstate their dividend payments anytime soon, whereas Best Buy's dividend hike is a strong signal to the market that management has confidence in Best Buy's turnaround.
The Foolish bottom line
The decision to make a dividend move in the midst of Best Buy's restructuring signals that management under the leadership of Hubert Joly is optimistic that the electronics retailer can turn the ship around for good. With its solid cash position, improving profitability and higher operating cash flows, it increasingly looks like Best Buy can repeat its 2013 turnaround success.