Great Company, But a Not-So-Great Investment
Over the past year, I have written several times about Best Buy and why it made sense as a long-term investment. However, my tune may be changing on this one. It's not that I don't believe in the company anymore. On the contrary, I think that Best Buy will continue to successfully adapt its business model to the changing retail environment, which it has already begun to do. The problem is that its shares are just too expensive now, considering the challenges that still face the company in the coming years.
Best Buy: Present and future
Since hitting bottom late last year, a lot of things have happened at Best Buy, both behind the scenes and in the public eye. Most notably, CEO Hubert Joly outlined the company's turnaround plan in November 2012, and then in March of this year the company stated its priorities. Let's take a look at the most important points of these statements, how Best Buy has attempted to implement them, and what they could mean to the company going forward.
First, and perhaps most crucial to the success of the company, Best Buy needs to grow and improve its online business if it hopes to compete with online giants such as Amazon.com . So far, Best Buy has taken significant steps toward this goal, including offering free shipping on all orders. This is actually a little better than Amazon, which offers free shipping only on orders of $25 and above.
Another area identified by the company as needing improvement is optimizing the use of its stores' physical space, which goes along with adapting to the online business environment. For example, the last time I walked in to a Best Buy store, a large amount of square footage was dedicated to CD's and DVD's, both of which have rapidly declining sales. The company aims to figure out how to sell its products in less space, and it has already made progress in this area. In fact, the company's total square footage is expected to decrease by about 3% this year. As more leases are renegotiated over the coming years, expect to see the square footage continue to drop.
Threats, competition, and other challenges
Online competitors such as Amazon are obvious threats to Best Buy. However, I believe that Amazon should feel a bit more threatened in this case, because it has much more to lose. Amazon has such a dominant position in online sales that a company offering a better deal (shipping or otherwise) could pose a major problem. Best Buy shareholders should still keep an eye out for Amazon, especially if the company starts taking away some of Amazon's market share, as I'm sure Amazon would respond with some competitive incentives of their own.
Of course there is always competition from other bricks-and-mortar stores such as hhgregg , a regional electronics chain primarily located in the Southeast and Midwest. hhgregg has a few advantages over Best Buy. Specifically, as a younger company that is still growing, hhgregg has used its current square footage more efficiently in its existing stores. The company is still expanding its store count, and it can tailor new stores to the current environment without hurdles to jump through like renegotiating leases.
My worry for Best Buy is that a viable competitor that runs more efficiently will be better positioned to price match online retailers. I don't see this as a major issue anytime soon, it's just something to watch.
Look at the numbers
A quick look at the numbers confirms my original suspicion. Best Buy shares are a little too expensive now for the risk investors are taking on. Surprisingly, earnings estimates have not changed all that much since the stock was trading for just over $11.
At that point, shares traded for just about 5.5 times forward earnings projections, making it look like a risk worth taking. Now, shares trade for about 14 times the estimates (which have been increased slightly), but the uncertainty in Best Buy's future remains. The 24 analysts who cover Best Buy have a wide range of projections, from $1.56 on the low end to $2.90 on the high end.
In my opinion, shareholders should be compensated for taking on additional risk with a discounted valuation. That was the case with Best Buy a few months ago, but not anymore. Pay attention to the company's progress, especially on the online front, but wait for either a significant pullback or an improvement in the company's fundamentals before jumping in.
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The article Great Company, But a Not-So-Great Investment originally appeared on Fool.com.
Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!
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