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Stock Analyst Update

Key Takeaways from Best Buy's Update

The retailer continues to improve its long-term competitive position thanks to innovative partnerships and improved customer experience, but shares remain overpriced.

Our takeaways from  Best Buy's (BBY) second-quarter update are similar to previous quarters, with the company improving its long-term competitive position but the market giving the stock more than enough credit. In our view, comps of 6.2% reinforces that Best Buy is more than just a beneficiary of favorable product cycles--home theater, gaming, health and wellness, and smart home were called out as key contributors--but also innovative partnerships like its Fire TV program with Amazon and improved in-store and online customer experience. We're intrigued by new platforms such as Total Tech Support (TTS) and the acquisition of GreatCall (a connected-health services platform for seniors), which can unlock new services growth and create product attachment potential. In fact, we now believe management's fiscal 2021 revenue target of $43 billion looks conservative, with $43.5 billion-$44.0 billion reachable even with increased competition (the basis of our no-moat rating).

On the profitability front, Best Buy continues to strike a balance between investment and cost optimization. Gross margins fell 30 basis points to 23.8% due to supply chain investments and TTS rollout costs but also helped by merchandise margins. The gross margin hit was more than offset by a 50-basis-point reduction in SG&A, with cost control measures negating specialty labor investments for the aforementioned service offerings, resulting in a 20-basis-point increase in operating margins to 3.8%. While the market appears concerned about the softer-than-expected third-quarter adjusted EPS outlook ($0.79-$0.84, versus consensus of $0.92), we're comfortable with Best Buy's service investments ahead of the 2018 holidays.

We're planning to add a few dollars to our $55 fair value estimate for more optimistic near-term sales assumptions. While we recognize the scarcity value of Best Buy's recent outperformance relative to other retailers and see the stock as a solid income play, we see shares as overvalued.

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R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.