What Factors Led To A Trend Reversal In Best Buy’s Stock?

In 2012, consumer electronics retailer Best Buy (NYSE:BBY) was suffering from high operating costs and impaired profitability. The company’s inability to upgrade its business model further added to the woes, culminating in the resignation of its then CEO, Brian Dunn. Online retailing was pressuring its business, as Amazon in particular gained market share by offering a broader offering at attractive prices for home delivery. However, after the arrival of its new CEO, Hubert Joly in 2012, Best Buy completely transformed itself into one of the frontrunners in the retail industry from its previous position of an industry laggard. Under the new leadership, the company managed to transform into a nimbler and leaner retailer with ability to ship products on immediate demand and more importantly at cheaper prices.

Our price estimate for BBY is $36, implying a 24% upside compared to its current market price.

See our complete analysis for Best Buy

Why Was Best Buy Struggling

• The primary reason Best Buy was struggling in 2012 was because its prices were not as competitive as that of online retailers like Amazon. Customers were using Best Buy for ‘showrooming,’ whereby they were trying out various product offerings at  Best Buy’s stores but were subsequently shifting to online retailers when it came to buying because of cheaper prices.
• Excessive SG&A expenses because of the presence of more than required numbers of middle managers had forced the company to keep prices high.
• A weak internet presence and insufficiently engaging shopping capability on its website.
• A lack of sufficiently robust distribution centers to support online shopping and the associated logistics. Best Buy had only 23 distribution centers with the primary purpose of feeding their stores inventory. 

How Did Best Buy Manage A Turnaround

• The company introduced Renew Blue, an initiative in which it slashed prices of both in-store and online products to win back customers.  It also  removed layers of management, streamlined business  processes and improved supply chain management. As a result, the company had successfully managed to cut costs by over $1 billion by the end of 2014. It also vastly improved its website for online retailing and made it accessible to customers and employees on systems throughout its stores.  Importantly, it worked to engage its customer facing employees, avoiding the destructive reductions-in-force used by competitor Circuit City, which ultimately failed.  On the contrary, it increased them to improve customer experience and hence boost sales.
• These aforementioned cost cutting initiatives did not flow to the bottom line since Best Buy invested these profits into cutting prices and increase training programs for employees
• Best Buy had a major problem into converting online visits by customers into online purchases. Best Buy’s online conversion rate was very low in 2013. In this particular year, Best Buy had a total of over 1 billion website visits but only converted those visits to the equivalent of $2.3 billion sales. Hence, Best Buy came out with a much improved version of its website to rival that of online retailers and succeeded in significantly improving its conversion rates
• Best Buy started its shipping from stores initiative and all of its more than 1000 plus retail stores were converted into mini-delivery centers with store employees doubling up into packing and shipping online orders.  In this way Best Buy improved its shipping time and that took it on par with Amazon

Impact On Financials

Because of the initiatives implemented by Best Buy, it managed to increase its operating income from $1.08 billion in 2012 to $1.45 billion in 2015. Its initiatives also led to an increase in its online sales as a percentage of total sales, evident from the previous quarterly earnings release.

The same performance is being reflected in the stock price of Best Buy.From an abysmal low of $11 in December of 2012, its stock price gradually increased to around $30 currently.

Why Best Buy Is Winning

Once Best Buy starts matching costs with online retailers like Amazon, it will be able to make use of its primary advantage , that of its in-store experience where customers can get  the opportunity to see, touch and try a particular product before actually buying it. The same is sure to drive large gains from online sales because of Best Buy’s ability to satisfy dual needs of the consumer. The first is to offer  customers a the in-store experience and the second is to offer prices at par with online retailers like Amazon. Accordingly, we believe that Best Buy’s revenues will decline at an average annual rate of 3% to $34.billion and an estimated EBITDA margin of 7% will translate into $ 2.5 billion in EBITDA by 2020. We have a price estimate of $36, which is roughly 20% ahead of the current market price.

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