Best Buy's Turnaround Doesn't Look Too Appealing
For nearly two years, Best Buy has been implementing a turnaround strategy called "Renew Blue" under the leadership of CEO Hubert Joly. Despite some initial doubts, investors have been pleased by Joly's plan: at about $27, the electronics retailer's stock is well above its level at the point Joly took over in August 2012.
But Best Buy's financial performance has not improved at the same pace as investors' confidence. The company did demonstrate some progress last quarter, as adjusted earnings per share grew (albeit slightly) and easily beat the company's guidance and analysts' expectations. However, sales declines have continued.
Best Buy seems to be relying on revolutionary new mobile products -- primarily from Apple -- to reignite revenue growth. However, Apple can offer great customer service at its own stores, nullifying Best Buy's key competitive advantage. Furthermore, retailers earn very low margins selling Apple products. As a result, I don't have very high hopes for Best Buy's comeback.
"Disappearing" cost cuts
One of the centerpieces of the Renew Blue turnaround plan from a financial perspective was significant cost-cutting. Best Buy has been reducing expenses through initiatives such as simplifying its management structure, optimizing store labor costs, using its purchasing power to get better deals from suppliers, and minimizing the cost of returns.
Management initially laid out a target of cutting $725 million in annualized costs. However, Best Buy cut $765 million in annualized costs during the first year of the program and therefore raised its target to $1 billion back in February.
Despite cutting nearly $1 billion in costs in the past year and a half, Best Buy's profitability has plummeted. In essence, cost reductions have only gone partway toward offsetting the earnings pressure caused by the competitive environment.
For example, while Best Buy's first-quarter adjusted EPS of $0.33 was up by $0.01 compared to the first quarter of fiscal 2014, it was down more than 50% from its adjusted EPS of $0.76 in the first quarter of fiscal 13. While the Renew Blue program was supposed to improve Best Buy's operating margin, an adjusted operating margin of 2.8% last year was roughly half of what the company achieved prior to the Great Recession.
It's clear that from a financial perspective, the Renew Blue turnaround program has not delivered its intended results yet. Is improvement just around the corner?
Slave to product cycles
Last year, Best Buy's revenue seemed to be stabilizing, but then it declined more than 3% in the first quarter. On its recent conference call, Best Buy didn't offer much hope for an immediate return to revenue growth. Management expects comparable-store sales declines in the next two quarters, absent any major product launches.
Best Buy seems to be waiting for the launch of Apple's iPhone 6, which is expected to drive significant upgrade activity in the U.S. this fall. To a lesser extent, the company may be hoping for a significantly improved iPad or a new Apple product category.
While new Apple products are virtually certain to create a huge wave of excitement in the U.S., it's not clear they will help Best Buy's earnings much. Apple has so much leverage compared to third-party retailers that retail profit margins for Apple products are minuscule. (In this way, Apple gadgets are similar to game consoles -- good for revenue, but bad for earnings.)
Foolish final thoughts
Best Buy CEO Hubert Joly deserves accolades for embarking on a massive cost-cutting program before it was too late. As a result, Best Buy has fared better than other consumer electronics retailers. While EPS has fallen, Best Buy is still solidly profitable, which wouldn't have been the case without the Renew Blue cost cuts.
That said, while I love a good turnaround story, this isn't a very attractive investment candidate. There may be a slight earnings increase this year thanks to reduced expenses, but much of Best Buy's revenue comes from declining categories and low-margin product lines. The path to long-term earnings growth is as murky as ever.
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The article Best Buy's Turnaround Doesn't Look Too Appealing originally appeared on Fool.com.Adam Levine-Weinberg is long January 2016 $560 calls on Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.
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