Best Buy’s Long-Term Digital and Services Narrative Remains Intact Despite Near-Term Pressure

Business Strategy & Outlook:

The company believe Best Buy is taking adequate steps to shore up its competitive position in an intensely competitive consumer electronics space. As the industry emerges from the shadow of COVID-19, it’s become clear that how people shop has permanently changed–with customers demanding seamless omnichannel access to favorite brands, quick fulfillment across channels, and tech solutions to more problems than ever before. As a result, Best Buy’s strategic positioning continues to resonate, with the firm leveraging its physical footprint for fulfillment and post-sale services, emphasizing its differentiated service offering, and experimenting with newer store formats, as the “one size fits all” retail model across trade areas appears antiquated. With more than one third of sales coming through digital channels in calendar 2021 (with management anticipating roughly 35% in perpetuity), the firm’s recent supply chain and e-commerce investments ($2.7 billion over the last five years, some 74% of total capital expenditures) look prescient. Next-day delivery now covers 99% of U.S. zip codes (up from 80% from pre-pandemic), allowing the firm to compete on more level ground against e-commerce competitors, like wide-moat Amazon–as buy-online-pick-up-in-store, or BOPIS) volumes, at 40% of e-commerce sales, remain more challenging for online-only stores to replicate.

Further, the company takes a positive view of the firm’s Totaltech program, with more than 4.5 million members receiving unlimited home tech support, VIP access to phone and chat teams, free delivery and standard installation, members-only pricing, and free extended warranties on Best Buy purchases. Through the program, Best Buy leverages its network of 20,000 Geek Squad agents, increases touchpoints with customers, and positions itself better to earn the first shot at servicing customer category needs. Finally, Best Buy Health remains intriguing, with lower price elasticity and auspicious tailwinds from an insurer pay model. However, competition in the space remains rife, as a number of moaty firms with extensive healthcare aspirations (Google, Microsoft, Amazon, Apple, Facebook) have invested heavily in the segment.

Financial Strengths:

The company thinks that Best Buy’s financial strength is sound, with the firm maintaining just $545 million in net debt at the end of the first quarter of fiscal 2023 and an investment-grade credit rating. With leverage well under 1 turn (0.3 debt/EBITDA at fiscal 2022 year-end), strong EBIT interest coverage, and no meaningful maturities until 2028, the company sees very little financial risk for the firm in the near to medium term. Access to a $1.25 billion credit facility adds a further degree of insulation. Consistent with historical patterns, it is expected that Best Buy will prioritize growth capital expenditures, strategic acquisitions, dividends, and share repurchases with its free cash flow (with free cash flow averaging 4.5% of sales through fiscal 2027). The firm also maintains an attractive dividend, with a 35%-45% payout target. The company’s annual share repurchases average a mid-single-digit percentage of shares outstanding through 2032, with our model calling for total shareholder returns of $11.3 billion through fiscal 2027.

Bulls Say:

With digital sales volumes projected to equilibrate at roughly double pre-COVID-19 levels, Best Buy should better compete for online volumes that it historically ceded to online competitors.
Improving route densities should strengthen the margin profile of small parcel e-commerce sales, with 35% of store “hubs” now accounting for 70% of ship from-store volume.
The Best Buy Totaltech program should increase touchpoints with the firm’s best customers, increasing spending and frequency relative to pre-program behavior.

Company Description:

With $51.8 billion in fiscal 2022 sales, Best Buy is the largest pure-play consumer electronics retailer in the U.S., with roughly 10.6% share of the aggregate market and north of 40% share of offline sales, per our calculations, CTA industry, and Euromonitor data. The firm generates the bulk of its sales in-store, with mobile phones and tablets, computers, and appliances representing its three largest categories. Recent investments in e-commerce fulfillment, accelerated by the COVID-19 pandemic, have seen the U.S. e-commerce channel roughly double from prepandemic levels, with management estimating that it will represent a mid-30% proportion of sales moving forward.

(Source: Morningstar)

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