uploads/2019/07/christopher-gower-_aXa21cf7rY-unsplash.jpg

Why Is Guggenheim Bullish About Best Buy Stock?

By

Updated

Guggenheim initiates coverage

On Monday, Guggenheim started to cover Best Buy (BBY) stock with a “buy” rating. Guggenheim thinks that Best Buy is undervalued compared to other large-cap retailers. Guggenheim is optimistic about Best Buy for numerous reasons. The company has strong vendor relationships and omnichannel capabilities. Best Buy also focuses on the services business. Guggenheim assigned Best Buy a target price of $80, which indicates an upside potential of 11% compared to the closing stock price on Monday.

Best Buy stock has risen 36% on a YTD (year-to-date) basis compared to the 18.7% rise in the S&P 500 as of Monday. The average 12-month target price of $76.68 for Best Buy stock indicates additional upside potential of ~7.0%. As of Monday, Best Buy stock was rated as a “hold” by 18 of the 28 analysts, while nine analysts recommended a “buy” and one analyst recommended a “sell.”

Strong first-quarter earnings growth

In May, Best Buy reported strong earnings for the first quarter of fiscal 2020, which ended on May 4. However, the company kept its guidance for fiscal 2020 unchanged despite the first-quarter performance. Best Buy considered the impact of increased tariffs on Chinese imports.

Best Buy’s first-quarter revenues grew 0.4% to $9.14 billion and matched analysts’ expectations. The company’s same-store sales growth was 1.1%. A 0.8% rise in the Domestic segment’s revenues drove Best Buy’s revenue growth in the first quarter. The growth was partially offset by a 5.2% drop in the International segment’s revenues partially offset the growth. Negative currency movements and lower same-store sales from the company’s Canadian operations caused lower revenues. Best Buy’s Domestic segment’s revenues increased due to same-store sales growth of 1.3% and the revenue contribution from the GreatCall acquisition. Store closures partially offset the growth.

Best Buy’s adjusted EPS grew 24.4% to $1.02 in the first quarter due to strong expense management, lower taxes, and a reduced average share count helped by share buybacks. As a result, the company crushed analysts’ EPS forecast of $0.86.

Growth strategy

To mitigate the impact of the slowdown in mature consumer categories, Best Buy has been focusing on growth categories like smart home and health and wellness. Best Buy acquired GreatCall in 2018—a leading connected health services provider for the aging population. With ~50 million Americans over 65 years old, Best Buy sees a tremendous growth opportunity in the health services market for aging customers. Through the GreatCall acquisition, Best Buy is offering services, mobile products, and connected devices customized for aging customers.

Best Buy is strengthening its GreatCall business by opening a third GreatCall caring center in Texas with 400 care agents. The center, which will open in October, would offer 24/7 technical phone support, concierge services, and emergency response for customers.

In May, Best Buy acquired Critical Signal Technologies—a health services company focused on the senior population. Critical Signal Technologies has ~100,000 senior subscribers. The company will help Best Buy grow in the commercial monitoring business.

Best Buy continued to strengthen its services business. The company expanded its Total Tech Support program. The program provides members with unlimited Geek Squad services for all of their products irrespective of where the products were purchased.

In the first quarter, Best Buy launched a lease-to-own program in 36 states. The facility allows customers to make periodic payments over a particular period for a product they desire. After the payments are complete, customers get full ownership. Best Buy plans to expand the program to nine additional states later this year.

Key suppliers

Best Buy continued to strengthen its relationship with its key suppliers through strategic deals. In June, Apple (AAPL) and Best Buy partnered to offer expert services and repairs for Apple products at ~1,000 Best Buy stores in the US.

Best Buy has strengthened its digital business, which is a key growth driver. In the first quarter, Best Buy’s online revenues grew 14.5% on a comparable basis. The company’s online revenues accounted for 15.4% of the Domestic segment’s revenues in the first quarter of fiscal 2020—compared to 13.6% in the first quarter of fiscal 2019.

Improving profitability

Best Buy’s gross margin increased by ~40 basis points to 23.7% in the first quarter of fiscal 2019. The gross margin increased due to the higher margin associated with the GreatCall business, higher product margins in the Domestic segment, and the improved gross margin in the International segment. Best Buy’s first-quarter operating margin increased by 80 basis points to 3.7%.

Given the highly competitive environment in which online retailers like Amazon (AMZN) are gaining more strength, Best Buy is taking various steps to enhance its productivity. Through productivity efforts, Best Buy generated $75 million in cost reductions and efficiencies in the first quarter of fiscal 2020. The company has generated cumulative savings of $575 million. Best Buy is on track to deliver $600 million in annualized cost reductions by the end of fiscal 2021.

Best Buy’s valuation

As of Monday, Best Buy was trading at 12-month forward PE ratio of 12.3x. The company’s forward valuation multiple has risen 2.8% since it announced its first-quarter results in May. However, Best Buy expects its fiscal 2020 adjusted EPS to be $5.45–$5.65 compared to its adjusted EPS of $5.32 in fiscal 2019. The company expects its fiscal 2020 revenues to be $42.9 billion–$43.9 billion compared to ~$42.9 billion in fiscal 2019. Best Buy expects same-store sales growth of 0.5%–2.5% in the current fiscal year.

Analysts expect Best Buy’s adjusted EPS to rise 7.0% to $5.69 due to revenue growth of 1.7% in fiscal 2020.

More From Market Realist