Can This Unsung Fundamental Hero Create More Gains For This 200% Performer?
In the first quarter of 2013, Best Buy's comparable online sales grew 16.3% year-over-year, and the company specifically noted that revenue growth was higher in states where online sales taxes had been implemented. In the company's most recent quarter, online revenue once again shined, further suggesting that online sales taxes might be closing the competitive gap between Best Buy and e-commerce companies. So, how should you play it?
Growing Online Presence
While investors have focused on the company's restructuring initiatives and gross profit improvements, it is clear that online sales growth has been the unsung hero of Best Buy's reemergence as a retail powerhouse.
In the company's latest quarter - causing Best Buy's stock to rise 13% -- total revenue was near flat as comparable store sales fell 0.6% year-over-year. In total, the company reported sales of $9.3 billion, with $7.81 billion being domestic.
Online domestic sales made up just $477 million, or 6.1% of total domestic sales. However, online comparable sales grew a whopping 10.5% year-over-year. If we look at comparable demand, which are pre-orders not yet recognized as revenue, such as game consoles, online sales increased 16% over the prior year.
The Importance Of Sales Tax
E-commerce as a whole has grown rapidly in the last decade, yet Best Buy had largely missed the boat in previous years, seeing its total revenue decline by double digits last year. However, to understand the recent surge you must go back to February of this year, when news struck of an online sales tax bill.
The likelihood of such a bill passing has continued to rise, as online sales now account for 5% of total retail (and growing). Since then, more states have implemented a sales tax, and in the process Best Buy's e-commerce business has exploded with gains.
You might wonder why such a bill is important to Best Buy. Well, consider a $300 game console, and a 6% sales tax. The price for consumers would be $318 if purchased at Best Buy, or more in states such as Tennessee, which has a near 10% sales tax.
However, if purchased on Amazon , $300 would be the price. Thus, in an industry with already low margins, Best Buy could not compete with large e-commerce companies, which led to much of the stock's five-year 80% loss prior to 2013.
What is the outlook?
Looking ahead, Best Buy has a slew of opportunities in front of it. Not only has the company maximized its square footage with new brand-specific product offerings, but the company will benefit from new product launches later this year from the likes of Samsung and Apple. In terms of performance, Best Buy has rallied almost 200% in 2013.
While Best Buy has seen its revenue stabilize year-over-year, top-line growth is not the most important metric moving forward, as the stock trades at just 0.25 time sales (50% cheaper than retailer Wal-Mart). Instead, the company needs profitability and higher margins. Looking at the industry, I think restrictions on sales taxes for e-commerce companies could weigh in the favor of Best Buy, as it might allow the company to be more aggressive in its pricing.
Currently, with operating margins of 2%, if Best Buy could slightly raise prices and get margins closer to 5% then I see no reason that it's not deserving of the same 0.5 times sales valuation of other retailers like Target and Wal-Mart. Thus, allow for upside of 100% from this point forward, if margins can rise.
What About E-Commerce Competitors?
While Best Buy's revenue of $9.3 billion was $170 million better than expectations, I think it is interesting that both Amazon and eBay missed revenue expectations during their most recent quarters.
This brings me to another point--whether or not such e-commerce leaders are now a "sell' with online sales taxes?
Like any industry, I think it depends on the company. In regards to eBay, I think it is definitely a sell, as revenue growth was just 14% during its last quarter. However, that growth was mostly driven by PayPal, as its Marketplace revenue grew just 10% year-over-year.
Moreover, eBay's valuation is supported by its operating margin of 20.75%, but with increased costs, margins are beginning to decline. Lastly, the company's growth driver, PayPal, could face significant competition for the first time, as companies Facebook, Google, and Apple are reportedly working on similar payment services. Thus, I say eBay is a sell.
Amazon is a different kind of company, as there are essentially zero margin expectations, and the company is valued solely on top-line growth. With e-commerce just 5% of retail sales, there is still a large market for Amazon to penetrate.
Not to mention the fact that the company's now entering the $560 billion a year grocery business, which could be a new driver of significant growth. Hence, at just 1.95 times sales, compared to eBay at 4.5 times sales, I think Amazon still presents a good long-term opportunity.
The competitive landscape has changed for Best Buy, and with new leadership, the company has responded nicely. So long as margins rise I think Best Buy's stock will trade higher. However, online sales will be crucial to the Best Buy equation, as these sales often produce higher profits, and with legislation we could see continued growth in the company's online sales. This unsung fundamental hero may be small in terms of impact, but with its growth, there's no doubt that online sales will become important to Best Buy's future and immediate stock performance.
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The article Can This Unsung Fundamental Hero Create More Gains For This 200% Performer? originally appeared on Fool.com.Brian Nichols owns Best Buy. The Motley Fool recommends Amazon.com and eBay. The Motley Fool owns shares of Amazon.com and eBay. 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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