Best Buy Earnings: Solid Quarter Overshadowed by Weak Industry Environment; Shares Remain Cheap

While narrow-moat Best Buy BBY posted solid second-quarter results, a murky near-term industry environment will likely lead us to trim our $100 fair value estimate by a mid-single-digit percentage. More concretely, we now pencil in just 1.1% and 2.2% 10-year cumulative annual growth rates in revenue and operating income, respectively, down from 1.3% and 3.3%—as we expect sluggish industry sales, normalizing co-branded credit card profitability, and commensurate challenges generating operating leverage to limit long-term operating profit upside. Shares continue to look attractive.

The firm’s quarterly results were solid, with $9.58 billion in sales and $1.25 in diluted EPS edging our $9.56 billion and $1.18 estimates, respectively. While the retailer still saw its domestic comparable sales fall by 6.3%, that was largely expected (and slightly better than our 7% decline forecast). That said, we harbor some concerns regarding management’s decision to lower its full-year sales estimates by about 1% at the midpoint (to $44.2 billion), which strikes us as an important signal, attesting to the substantial ongoing challenges faced by the firm’s domestic consumer.

Our longer-term concerns are twofold. One, in a competitive industry with a high degree of customer price sensitivity, infrequent purchase occasions, and nearly perfect price comparison, we believe that Best Buy will struggle to generate sales growth ahead of inflation in hourly labor and store rental costs. Thus, we think it will need to “run in place” to maintain its historical 4.5% to 5% GAAP operating margin, even as it adds higher-margin revenue streams like Best Buy Ads and Best Buy Health. Two, with co-branded credit card profit sharing revenue (qualitatively) likely to decline in the back half of the year and into fiscal 2025, we foresee further margin degradation in the year to come, with our revised projections suggesting that Best Buy doesn’t recover to prepandemic levels of profitability until 2027.