Is Best Buy's Cost-Saving Plan Enough?
We're maintaining our fair value estimate for now, but we'll be carefully monitoring the effects of the struggling retailer's transformational efforts on the business, says Morningstar's R.J. Hottovy.
We're maintaining our fair value estimate for now, but we'll be carefully monitoring the effects of the struggling retailer's transformational efforts on the business, says Morningstar's R.J. Hottovy.
Following several quarters of market share losses and waning profitability, Best Buy (BBY) announced several steps to improve its competitive position in the rapidly evolving consumer electronics retail industry in conjunction with its fourth-quarter update. Among the highlights from Best Buy's transformational strategy are $800 million in planned cost reductions by fiscal 2015 (ended January 2015), with $300 million coming from 50 domestic big-box retail store closings and strategic remodels, $300 million on corporate and support cost structure reductions (IT service savings, procurement on nonmerchandise purchases, reduced outside consultants, and a reduction of 400 positions in corporate/support functions), and $200 million in cost of goods sold savings (reduced product transition costs, lower return/exchange expenses, supply chain efficiencies).
As we've advocated for some time, these decisions should help to lower the company's overall cost structure, which can be invested in more aggressive pricing to better compete with rivals like Amazon (AMZN), Wal-Mart (WMT), and Costco (COST) and improve the overall customer experience. Some of the cost savings have also been earmarked to fund key growth initiatives, such as building out more productive small-box formats, expanding digital capabilities, and further penetrating the Chinese market--each of which strikes us as prudent sources of capital. Taken together, we view these initiatives as a step in the right direction for the beleaguered retailer, though it remains unclear whether they are sufficient enough to curtail and reverse recent market share losses or whether the company needs to evaluate even more aggressive cost-cutting measures to stay competitive. Based on fiscal 2012 results and management's fiscal 2013 guidance, we are not changing our fair value estimate, though we will continue to monitor the impact of these transformational efforts on Best Buy's overall business.
Best Buy's fourth-quarter results were generally in line with our model, though there appeared to be some degradation in U.S. sales trends following the company's holiday sales update in early January. Total company comparable-store sales fell 2.4% for the period, including a 2.2% decrease in the United States and a 2.9% decline internationally. This compares with the comparable sales decline of 1.2% in December (including 0.4% and 4.3% declines in the domestic and international segments, respectively), suggesting the price competition in the consumer electronics category remains intense. This brought full-year revenue of $50.7 billion just below management's previous forecast range of $51.0 billion-$52.5 billion, likely explaining Thursday morning's sell-off.
The 45-basis-point decline in consolidated full-year gross margins to 24.8% and the 2% increase in selling, general, and administrative dollars were consistent with the outlook provided on management's third-quarter call, but still reflective of the difficulties in profitably driving store traffic in a commodified retail category with several low-cost rivals. We've long held the stance that consumer electronics consumers will gravitate to the retailers with the lowest prices regardless of the level of the service offerings, and we view Best Buy's cost-cutting efforts and subsequent price investments and customer experience efforts as a right step in narrowing the gap with larger online players and mass merchants. Still, we are not convinced initiatives outlined in Thursday's press release will drive enough price parity to stem recent market share losses.
At first glance, management's fiscal 2013 guidance appears realistic for a retailer in transition, including revenue of $50.0 billion-$51.0 billion (representing flat top-line growth for the year), comparable-store sales declines of 2%-4%, a 4%-11% decrease in operating income dollars (after adjusting for restructuring costs, discontinued operations, and one-time items), and adjusted earnings of $3.50-$3.80 per share. Until we gain comfort with Best Buy's transformation efforts, we continue to forecast that over the next five years, top-line growth trends will remain in the low single digits, driven by low-single-digit comparable-store sales growth but tempered by a reduction in U.S. retail selling square footage, with consolidated operating margins contracting to around 3%.
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