With over one-fifth of the U.S. consumer electronics market, Best Buy Co., Inc. (NYSE: BBY) is a haven for both techies and trainees alike, as their network of 1,150 retail stores offers consumers a fix for every modern need. From computers to cameras, Best Buy has its fingers in every proverbial pie imaginable, though it has faced recent turmoil in terms of shrinking revenues and store downsizings. Just a few weeks ago in late March, the company missed Wall Street’s Q4 earnings estimate of $17.15 billion, reporting just over $16 billion instead. At this same time, Best Buy announced that it would close around 50 stores by the summer. These declines have exacerbated the negativity surrounding BBY stock, as it had already lost 15 percent of its value in the previous year, while continuing to plunge another 19 percent this April.
Shortcomings like this were almost unfathomable just three years ago, when Best Buy’s biggest competitor Circuit City closed its doors. At this time, it was believed that the only major competition Best Buy would face would be from mass merchants and electronic warehouse-type businesses. It has become apparent, however, that online-only competitors like Amazon.com, Inc. (NASDAQ: AMZN) and GameStop Corp. (NYSE: GME) are turning Best Buy’s stores into places where consumers merely test-drive tech products before purchasing them online. To alleviate these concerns, BBY has pledged to reshape their now-defunct business model by placing a greater focus on Internet-based sales, product discounts, and in-store efficiency. All of this translates into uncertainty for investors looking to go long BBY, though it seems that some hedge funds already have. It is possible that these institutional investors have noticed something fundamentally attractive about the consumer electronics giant.
Delving into the fundamentals, Price-to-Earnings and Price-to-Cash Flow ratios signal that BBY is severely undervalued in comparison to all of its competitors in the consumer electronics industry. BBY’s P/E ratio is a meek 7.5X compared to the industry average of 23.5X and to its own ten-year historical average P/E of 16.3X. Investors are valuing the earnings of aforementioned web-based companies AMZN (137.0X) and GME (9.3X) higher than Best Buy’s, and the same can be said about its more traditional competitors: RadioShack Corp. (NYSE: RSH) at 9.2X, Wal-Mart Stores Inc. (NYSE: WMT) at 13.1X, and HHGregg, Inc. (NYSE: HGG) at 9.8X. In addition, Forward P/E ratios, which are based on analyst estimates of future earnings, give a similar conclusion. BBY’s Forward P/E of 5.7X is below AMZN (72.0X), GME (6.4X), RSH (8.0X), WMT (10.9X), and HGG (8.5X).
Investors are also wise to look at the sentiment surrounding a company’s cash flows. Inexplicably, BBY is grossly undervalued by this metric too, as its P/CF of 2.3X is far below its 10-year historical average of 10.7X and the current industry average of 12.4X. In Best Buy’s case, preliminary estimates place the company’s expected cash flow at $3.27 billion in the current year, which would be an astounding one-year increase of 175 percent. If these expectations hold, this would provide an obvious boon to BBY shareholders. Not surprisingly, competitors’ P/CF ratios are all higher when looking at AMZN (22.2X), GME (5.0X), RSH (2.8X), WMT (8.5X), and HGG (5.0X). In the long run, these companies’ cash flows should be valued similarly, and at the very least, it does not make intuitive sense that BBY’s current cash flows are being valued so much lower than their average over the past 10 years.
It is also worth considering the state of Best Buy’s surrounding macroeconomic environment. Primarily dependent on consumer demand, the electronics industry’s future is bright, as innovative products like e-book readers, smartphones and tablets continue to be extremely popular. Specifically, industry-level sales hit a post-recession high in 2011, with 2012 growth forecasted at 3.7 percent. Additionally, price declines – most notably in the TV arena – have made these products more affordable to consumers. Both of these factors will obviously help Best Buy, though the company faces a few firm-specific issues in the coming months. As mentioned above, BBY missed its most recent earnings estimates, while announcing it will downsize its network of stores by approximately 5 percent. In an effort to prevent sales from sliding further, the company has focused on eliminating its price markup over online retailers while promising a stronger commitment to its web-based store. Despite these undesirable headlines, BBY’s overall revenue growth remains healthy, as its 3-year average revenue growth of 7.9 percent exceeds the industry average of 7.5 percent. It is decidedly middle-of-the-road compared to its primary competitors: AMZN (35.9%), GME (2.7%), RSH (1.2%), WMT (3.4%), HGG (18.3%), though near-8 percent growth is nothing to shake one’s head at.
After considering these factors, it does seem possible that an imbalance of negative sentiment is surrounding BBY. Even if its revenue growth continues to be ‘average,’ valuation indicators show that investors should push its share price higher. In the long run, the stock will be fairly valued. This may be why some of the financial industry’s most prominent fund managers have shown interest in the stock. At the end of last year, 33 hedge fund managers held shares of BBY in their portfolios, compared to 28 in Q3 of 2011. Of the ten funds with the largest percentage of their holdings in BBY, eight elected to expand their positions rather significantly. Some of the most bullish managers included David Einhorn, Cliff Asness, Ray Dalio, and Steve Leonard. In fact, David Einhorn’s Greenlight Capital has cited BBY as a possible takeover candidate. This article details some of these speculations, but points out that just because BBY’s price has fallen so far does not mean that we will see an acquisition. Either way, it is ultimately up to investors to trust the fundamental analysis, which does reveal that the stock is currently trading at a deep discount. Citing this reasoning, undervalued Best Buy (BBY) is a good bet bounce upwards by next spring.
