Published December 17th, 2016 by Bob Ciura
With the holiday shopping season upon us, it’s an opportune time for investors to compile a holiday stock shopping list.
Many consumers will be shopping at Best Buy (BBY) this holiday season.
Best Buy is a Dividend Achiever, meaning it has raised its dividend for more than 10 consecutive years.
You can see the entire list of all 273 Dividend Achievers here.
The company has seen its share of ups and downs over the past few years. Retailers as a whole are under pressure from online competition from the likes of Amazon.com (AMZN).
Despite this, Best Buy is thriving. The stock has gained 56% just since the beginning of the year, and is near an all-time high.
This article will discuss how Best Buy beat the competition, and why it could be a worthwhile dividend growth stock to consider buying.
Best Buy was founded by Richard Schulze in 1966. It was originally called Sound of Music before the name changed to Best Buy in 1983.
Today, Best Buy generates nearly $40 billion in annual sales.
This is a challenging period for Best Buy. A few years ago, there was a great deal of fear surrounding Best Buy stock. Worries over the dreaded “show-rooming” effect soured investor sentiment in recent years.
Show-rooming was a consumer trend in which shoppers would go to physical retail stores such as Best Buy to inspect gadgets in person and ask questions to staff. They would then leave the store without purchasing the item, and buy it online for a lower price.
This fear caught on and spread like wildfire—it caused Best Buy stock to fall to $10 in early 2013.
Best Buy has come roaring back, thanks largely to its “Renew Blue” turnaround plan. It launched the plan in 2012. The initiative revolves around providing a better experience for customers.
Source: Renew Blue Investor presentation, page 5
Management placed focus on higher levels of customer satisfaction, reducing company costs, and promoting the most popular products to satisfy the current trends.
Separately, a key part of the turnaround plan was to invest significantly in e-commerce. This has paid off in a major way, it represents Best Buy’s most compelling growth catalyst.
As the old saying goes, if you can’t beat ‘em, join ‘em.
Best Buy realized that online shopping was not a passing fad—it is here to stay. Rather than insist on fighting a losing battle, Best Buy built its own e-commerce platform. The results speak for themselves—Best Buy has gotten sales growth back on track.
Source: Fiscal 2016 Annual Report, page 3
E-commerce sales rose 13% last year, and now comprises 15% of Best Buy’s total U.S. revenue. Best Buy’s online platform now generates $4 billion of annual revenue.
Furthermore, Best Buy’s cost-cutting efforts have resulted in much better profit margins in recent years.
Source: Fiscal 2016 Annual Report, page 3
This will help Best Buy boost earnings-per-share growth.
A closer connection with customers allows Best Buy to understand what consumers want. Last quarter, U.S. comparable sales increased 1.8%. Growth was led by demand for wearable devices, and sales of home appliances.
Two areas consumers are spending more on are their health and their homes. Best Buy is capitalizing on this and should continue to benefit from these catalysts.
Competitive Advantages & Recession Performance
The retail industry is fiercely competitive. And, there are not many barriers to entry. This means Best Buy does not have many competitive advantages working in its favor.
However, the most important competitive advantages for a retailer are scale and brand strength. The good news is that Best Buy has both of them.
First, in the retail industry, price is everything. Shoppers buying appliances or electronics search different stores based largely on which one offers the lowest price. In order to keep prices low, it is critical for a retailer to reap the benefits of scale.
Best Buy has over 1,000 stores in the U.S., where more than 70% of the population lives within 15 minutes of a Best Buy store. This makes it very difficult for a competitor to undercut Best Buy on price.
Second, Best Buy retains a positive brand image. When consumers think of electronics, Best Buy comes to mind. Much of this is the result of Best Buy’s significant advertising:
- 2014 advertising expense of $757 million
- 2015 advertising expense of $711 million
- 2016 advertising expense of $742 million
Still, Best Buy is not immune from economic downturns. With a business model reliant on a financially-healthy consumer, Best Buy struggled during the recession of 2008-2009. The company’s earnings-per-share during the Great Recession are shown below:
- 2007 earnings-per-share of $3.12
- 2008 earnings-per-share of $2.88 (7.6% decline)
- 2009 earnings-per-share of $3.10 (7.6% increase)
- 2010 earnings-per-share of $3.43 (10.6% increase)
Best Buy’s earnings-per-share declined in 2008, but the company remained strongly profitable. And, earnings-per-share quickly recovered and regained their lost ground by 2010.
Valuation & Expected Total Returns
Best Buy stock trades for a price-to-earnings ratio of 14. This is significantly cheaper than the S&P 500 Index, which has an average price-to-earnings ratio of 26.
Best Buy stock is undervalued relative to the S&P 500, but retail stocks typically trade for discounted valuation multiples. And, since 2000 Best Buy stock has held an average price-to-earnings ratio of 12.
So, Best Buy appears to be fairly valued.
That being said, investors can still earn decent returns moving forward, based on earnings-per-share growth and dividends. A possible breakdown of earnings-per-share growth could be as follows:
- 2%-4% revenue growth
- 2% share repurchases
- 1% margin expansion
When adding in the 2% dividend yield, investors could earn 7%-9% annual returns moving forward.
Best Buy is back, and investors are reaping the benefits. Investors can expect Best Buy to stuff their stockings with cash.
Earlier this year, the company raised its cash dividend by 22%. It also paid an additional $0.45 per share special dividend. Lastly, it authorized a $1 billion share buyback program.
Best Buy is fairly valued, but it is an interesting stock for an above-average dividend yield and dividend growth.