The Case for Best Buy

    While running a screener searching for financially healthy companies that provided excellent returns on capital employed I stumbled upon Best Buy. In this post you can find the reasons why I think there could be a great buying opportunity in Best Buy at the moment. 

Pros: here I will first start with some comments about the business itself and then I will get into the financials of the company through an analysis of some ratios.

• The company adapted really well to the "pandemic environment" through their online store and their store pick-up model. They were able to retain 70% of their sales during the first month of lockdowns, which is really impressive considering that in the end Best Buy is still considered a retail business.
• Best Buy is expanding changing their business model to accommodate more online sales and transition away from the dependency on their brick and mortar stores. For example, they are focusing more on the servicing of their clients' devices, they have a "Geek Squad" that solves doubts regarding electronics available to clients who pay a subscription, and they have a subsidiary dedicated to products to take care of senior individuals (greatcall). They also have strong B2B operations.
  
• Best Buy's top management acted in a very coherent way during the first few months of the pandemic. They cut down their own salaries by 20 to 50%, they suspended their share buyback program, and they reduced inventory levels for products that were less in demand and focused on keeping high inventory levels for their top-selling items. Furthermore, the company reduced their marketing and capex expenses to prioritise the more key areas of the business in a crisis like the one lived at the beginning of the pandemic.
  
• Today everyone is using technology more than ever, and electronic devices keep gaining popularity. If we need someone to help us decide what phone, what computer, or what household appliance to purchase we could go to the internet or a friend, but stores such as Best Buy or Media Markt (in Europe) have a lot of experience and a knowledgeable workforce that helps their clients choose devices that better fit their needs.
  
• The gross margin of the company has been stable at around 22-25% for the last 10 years, which might indicate that, if needed, Best Buy could increase their prices and still retain their level of sales. This is something particularly admirable considering the rise of e-commerce retailers, especially Amazon, during the last 10 years.
  
• Their operating margin has been increasing during the past 5-7 years, indicating that the company is able to keep their operating costs under control. This, combined with the stable gross margin, could lead to higher profitability.
• Excellent return on capital employed (ROCE) of 32.3%. The company is able to invest the capital at their disposal and obtain excellent return on those investments. This could potentially lead to great value-creation in the future. For comparison, Apple has a ROCE of 32.3%, and the median for the companies in the S&P 500 index is just 9.9%. Best Buy's ROCE has also been above 22% for each of the last 10 years, which already makes it outstanding.
• Operating cash flow margin (CFO/Revenues) of 10.4%, meaning that they are able to turn 10 cents out of every dollar of sales into actual cash. The company then invests 15% of this cash into their capex needs. 
  
• Their Total Liabilities-to-Total Assets ratio is above 76%, which isn't low at all, but it can be justified due to the following reasons:
• The Debt-to-Equity ratio stands at 89%, meaning the company gets more capital from equity than from debt.
• Interest coverage ratio of 49.8x (median S&P 500 company stands at 7.29)
• Capex coverage ratio of 6.9x
• Liquid balance sheet: current ratio of 1.2 and quick ratio of 0.6.
• Valuation:
• Free Cash Flow yield of 14.4%. For reference, Terry Smith, CEO and CIO at Fundsmith, suggests that a ratio above 6% represents a possible buying opportunity, and a ratio below 2% indicates that a stock is overpriced. Other companies such as Apple, Costco, or Walmart stand at 4.1%, 3.5%, and 6.6%, respectively. Additionally, the median FCF yield for S&P 500 companies is 3.9%.
• PE ratio of 17.26. Apple, Costco, and Walmart stand at 29.55, 38.05, and 29.47, respectively, and the S&P 500 average is at 39.76.
• Regarding dividend yield, Best Buy stands at 2.4%, with a payout ratio of 31.6%. The median S&P 500 company has a dividend yield of just 1.4%.

Cons:

• Lack of presence outside North America. Sales are still extremely reliant on the United States. Currently Best Buy operates uniquely in the US, Canada, and Mexico.
• The FCF Yield I previously used to value the company could be inflated due to good financial performance of the company for the past fiscal year. Logically, this measure would decrease if the market cap of the company increases and/or the FCF of the company decreases. The risk here could be that this measure is above 14% not because the company is undervalued, but because the FCF is inflated compared to a more "normal" fiscal year.
• Beta (5 year, monthly) of 1.58, pretty volatile. Using only this information, if the market were to have a correction in the near future BBY could fall disproportionately.
• The great financial health of BBY could be due to a temporary increase in sales as more people needed to upgrade their electronic devices due to the work-from-home conditions of the past year.
• If Best Buy is not able to transition more and more into online sales their sales and market share could suffer in the future.
• Price is at an all-time high.

Other facts:

• > 50% of the board and the CEO are women.
• Their "teen tech" centres serve as after-school centres for learning about technology for less fortunate teenagers around the US.
• They take care of recycling or responsibly disposing of electronic equipments that clients might bring to their stores once they are old or broken.