An Analysis of Best Buy’s Turnaround And Its Plans For FY 2016

A few years ago, most people expected Best Buy (NYSE: BBY) to go down the same lane as its competitor Circuit City, which after years of losses, went bankrupt. Even RadioShack went down a similar path earlier this year as online giants like Amazon took away sales from brick-and-mortar stores. But, Best Buy has been a completely different story, thanks to the company’s turnaround strategy, Renew Blue.

Best Buy’s return on equity (ROE), which is a widely used indicator of a company’s profitability, stood at a negative 8% at the end of 2011. While other similar companies went bankrupt, Best Buy took its online rivals head-on and turned around its operations. By matching competitors on price and focusing on providing a superior customer experience, they were able to prevent a significant fall in sales. While price competition would have hit margins significantly, the company averted this by cutting down costs significantly. They streamlined their operations, established an online presence, shut down low-performing stores and used all other stores as distribution centers for online sales. By the end of 2014, the company managed to generate an ROE of a positive 8%.

Digging a level deeper, the turnaround is also evident in other metrics which contribute to the ROE. According to DuPont analysis, ROE is the product of a company’s net profit margin, its asset turnover and the financial leverage used. Lets take a look at how the company fared on each of these metrics during this period (2011-14).

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Net Profit Margin

Best Buy’s promise to match competitors on price put the company’s gross margins under pressure. They would price match all local retail competitors (including their online prices) and some major online retailers, including Amazon.com. While the company sacrificed gross margins to draw customers to stores, it more than made up for the losses by cutting down SG&A expenditure, especially in the latter half of this period. At the start of 2013, Best Buy announced a slew of initiatives as a part of its Renew Blue strategy, which included driving supply chain efficiencies and reducing SG&A costs. By the end of 2014, the company exceeded its cost reduction target of $725 million and later increased its target to $1 billion. These factors resulted in a significant positive impact on the company’s net profit margin, as shown below.

Asset Turnover and Financial Leverage

Asset turnover, which represents a company’s ability to generate sales from its assets, remained relatively stable compared to the margins.  While sales fell from a little over $45 billion in 2011 to about $40 billion in 2014, the company’s asset base decreased from $16 billion to a little over $15 billion (net property and equipment halved during this period from $3.5 billion to $2.3 billion). Best Buy reduced its asset base by closing down low-performing stores and also improved revenue generated per square feet (equivalent to sales from assets) through store space optimization. At the same time, the company also managed to reduce financial leverage by about 20% from 3.67 in 2011 to 3.05 in 2014.

What Best Buy Plans To Do In the Coming Fiscal

Encouraged by the success of its turnaround strategy, Best Buy plans to continue its cost cutting efforts in FY 2016 to battle industry and economic pressures. The company has set itself a target of approximately $400 million in cost reductions and gross profit optimization, over the next three years. It will utilize these incremental savings for investments in delivery and cost control and other growth initiatives, which are expected to amount to approximately $100 million to $120 million.

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