EUR 850.00 For Business Accounts Only

Morningstar | Operational Improvements, Enhanced Services Position Best Buy to Exceed Fiscal 2021 Targets

Our takeaways from Best Buy's second-quarter update are similar to previous quarters, with the company improving its long-term competitive position but the market giving the stock more than enough credit. In our view, comps of 6.2% reinforces that Best Buy is more than just a beneficiary of favorable product cycles--home theater, gaming, health and wellness, and smart home were called out as key contributors--but also innovative partnerships like its Fire TV program with Amazon and improved in-store and online customer experience. We're intrigued by new platforms such as Total Tech Support (TTS) and the acquisition of GreatCall (a connected-health services platform for seniors), which can unlock new services growth and create product attachment potential. In fact, we now believe management's fiscal 2021 revenue target of $43 billion looks conservative, with $43.5 billion-$44.0 billion reachable even with increased competition (the basis of our no-moat rating).

On the profitability front, Best Buy continues to strike a balance between investment and cost optimization. Gross margins fell 30 basis points to 23.8% due to supply chain investments and TTS rollout costs but also helped by merchandise margins. The gross margin hit was more than offset by a 50-basis-point reduction in SG&A, with cost control measures negating specialty labor investments for the aforementioned service offerings, resulting in a 20-basis-point increase in operating margins to 3.8%. While the market appears concerned about the softer-than-expected third-quarter adjusted EPS outlook ($0.79-$0.84, versus consensus of $0.92), we're comfortable with Best Buy's service investments ahead of the 2018 holidays.

We're planning to add a few dollars to our $55 fair value estimate for more optimistic near-term sales assumptions. While we recognize the scarcity value of Best Buy's recent outperformance relative to other retailers and see the stock as a solid income play, we see shares as overvalued.

Looking closer at management's updated financial targets, we believe the company is poised to come in toward the high end of its updated fiscal 2019 targets, including revenue between $42.3 billion and $42.7 billion, 3.5%-4.5% comps, operating margins of 4.5%-- flat versus fiscal 2018, with improved productivity store metrics offsetting supply chain investments and the national TTS rollout--and adjusted EPS of $4.95-$5.10. Although management has not updated its 2021 outlook (introduced at last September's investor day), we believe aforementioned top-line initiatives and $600 million in annualized cost reductions the next few years could drive upside to its operating profit target of $1.9 billion-$2.0 billion (implying 4.5% operating margins) and adjusted EPS goal of $5.50-$5.75.