What to Do About Best Buy

Oh, elusive value! How you taunt us with your quirks and tricks. But you've been snared this time, found lurking in plain sight. Now you are mobbed -- captured in the midst of your work and carried by the masses to sure financial gains. Value, you are found out.

Or maybe not. Perhaps you, once again, seemed to have appeared in plain sight but still lurk off in industries that no one ever examines -- copper chicken-wire producers, for instance. Perhaps Best Buy (NYS: BBY) , then, is not more than it seems. Perhaps it is even less.

Look at all these signs!
To the value-minded, Best Buy must seem like a misdirection given by a cheap GPS in your own neighborhood -- it says "turn here for value," but you know that taking a left drops you in a dead end. For investors desperate to be part of a turnaround, Best Buy might look like a great idea. The stock is down 50% this year. Revenue in the last quarter fell 4%. But despite all that, the company has household brand recognition, with one of the biggest online retail stores in the U.S. and more than 1,400 locations. Despite its sharp fall, the founder is still interested in buying the company back, potentially offering a windfall for shareholders. This is value in its purest form, one might easily think.

But there are very disturbing signs as well. Best Buy announced a reduction in its free cash flow forecast of close to $500 million, which it blamed on lower profits and increased inventory. Same-store sales also fell last quarter, which is bad news for the brand's long-term strength. One of Best Buy's selling points is its after-sale support, often provided by the company's Geek Squad. If consumers begin to worry, en masse, about the longevity of the company, it could affect sales that rely on that support. Who wants to buy a warranty from a company that won't be around this time next year?

Expert advice
One of the more pleasing things, intellectually, about finding a real value stock is that the market hates it, so investors who see something unusual get to feel extra savvy. Best Buy certainly has the market-hatred trait. Fitch Ratings just downgraded the company, in part because of "skepticism that the strategic plan laid out by new management, which shed some light on cost cutting programs and initiatives to reinvigorate sales, will achieve the targeted improvements and curb market share losses and profitability declines." Ouch. Its new BB- rating puts it at the bottom end of the agency's "speculative" range.

Fitch was most worried about how the consumer landscape is changing, with sales quickly moving to online retailers such as Amazon.com (NAS: AMZN) . Oddly, that seems to be one spot that Best Buy is still managing decently. In the last quarter, online sales grew 10%. That's a far cry from its competitors' growth -- 27% at Amazon and 16% at Wal-Mart (NYS: WMT) last quarter -- but at least the figure isn't falling. And according to online sales guide InternetRetail.com, Best Buy still sells more online than Target (NYS: TGT) or Costco (NAS: COST) .

The bottom line
But I don't think online is going to be Best Buy's savior. It may end up being a safety net, something that simply keeps the company from completely sinking. Best Buy's claim to value is thin, at best. Its free cash flow position is in jeopardy, its market share seems to be shrinking, and its basic business model increasingly looks outdated. I think the analysts from Raymond James put it best when they wrote: "[W]e do not understand why Best Buy would be an attractive buyout candidate. In our view, the combination of significant comp sales declines, gross margin rate contraction, and intense competitive pressures is not a business model that a private equity suitor would find attractive."

Best Buy is bad news, and I don't think any amount of success on Black Friday is going to meaningfully change its position. Investors looking for strong retailers should check out The Motley Fool's premium guide to Costco. As a longtime recommendation, we've got all the details on what the company is doing right, and what investors need to look out for. Readers can get all the details, by signing up for our report today.

The article What to Do About Best Buy originally appeared on Fool.com.

Fool contributor Andrew Marder has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Best Buy, and Costco Wholesale. Motley Fool newsletter services recommend Amazon.com, Best Buy, and Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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