Stocks of Best Buy (NYSE: BBY) have fallen sharply over the past year. Demand for electronics has fallen more than expected as consumers change their spending habits. But I still think Best Buy’s strong balance sheet and cheap valuation make its shares undervalued at the current price.
The environment is deteriorating
The fundamental consumer electronics environment is deteriorating. The US Census Bureau reported that sales at electronics and appliance stores fell 5.3% year over year. This is the worst of all the categories reported. The category’s adjusted sales were down month-over-month.
Best Buy was hit hard by the highly volatile demand environment. The company expects its sales to decline 11% year-over-year. Management officially withdrew its guidance targets for 2025. They said they saw evidence that consumers were spending less and selling less.
The company saw a 16.6% year-over-year decline in its computing and smartphone segment. The consumer electronics segment was also hard hit, down 14.7% year-on-year. Yet there are signs of resilience. All segments of the company are still seeing sales above pre-pandemic levels.
Best Buy’s forward sales and earnings outlook are unclear. Even the management of the company has trouble predicting future results. These results will depend on the uncertain macro environment. The consumer electronics industry currently has a large inventory overhang. Best Buy mostly avoided those headwinds. But these dynamics can fuel a heightened promotional environment. We’re already seeing an increase in sales events, like Amazon (AMZN) introducing a second Prime Day. This could drive down margins across the category.
Why I think Best Buy’s fundamentals are still strong
The fundamental environment is clearly deteriorating. But I think Best Buy is still a solid company.
I believe physical stores are a competitive advantage in consumer electronics. A physical presence is especially useful in categories without strong brand loyalty. Examples of such products are televisions and household appliances. Best Buy has also developed a service component for its business. This and the company’s geographic footprint constitute an enduring moat. That’s why brands like Samsung use Best Buy for repairs and customer support.
The company is also expanding its Best Buy Outlet brand. This segment focuses on open boxes and refurbished items. This is a segment in which online retailers may find it more difficult to compete. It can also allow the company to take advantage of declining customers. Clearance sales through this segment can make twice as much money as alternative channels.
But I think Best Buy’s strong financial profile is the most compelling part of this investment.
The company has a relatively healthy inventory, down 6% year over year. Currently, many other retailers are facing a large inventory overhang. But looking at raw inventory numbers can be misleading. There are still some stock-outs in some high-demand categories. Demand fell sharply in other areas. During their last earnings call, management provided some details on their inventory position.
Overall, our inventory is healthy and reflects an evolving mix of products in our network, including higher ASP devices and larger screen TVs, which also have longer lead times and inventory turnover. slower. Although we took more markdowns than last year, the level reflected a normalization of pre-pandemic activity.
In our inventory numbers, there are categories where we have sufficient stock and still pockets where we are limited. In our industry, it’s not that simple whether we have inventory or not. This can be incredibly variable depending on the product and even the brands of a particular product. For example, we are still experiencing inventory constraints in key computing and gaming models and brands…While managing inventory against current demand is important, we also want to ensure that we are well positioned to react to the constant evolution of the consumer. Needs.
Management believes the promotional environment has returned to normal pre-pandemic levels. It’s promising that Best Buy isn’t planning a drastic increase in markdowns. Even if the sales go down, I think the company should still make a decent profit.
The company also has a healthy net debt position. Its balance sheet has $1 billion in long-term debt, only about 5% of its enterprise value. All of their debt is low interest and none matures until 2028. I think that’s a healthy financial position. The company is able to survive a downturn and could come out stronger on the other side.
Overall, I think Best Buy is well positioned to weather the current economic downturn. Its balance sheet is solid and the company is in a good position to increase its market share.
High dividend and cheap valuation from Best Buy
Best Buy is trading at a cheap valuation. According to analyst estimates, the company is trading at a forward P/E of 11 and an EV/EBITDA of 6.8. I think that this cheap valuation should cover some of the downside potential. Howevershares of Best Buy also enjoyed a good various expansion for several years. If this trend returns, the company could have more short-term downsides. I still think the company is more stable than the market is predicting.
The company has the ability to return a lot of money to shareholders. He has a long track record of generating free cash flow well above GAAP net income. Even in the worst quarter since May 2020, the company still generated strong free cash flow. In the last quarter alone, the company generated a free cash flow return of 3%.
Best Buy pays a regular dividend at a yield of 5.4%. It is unlikely to increase much in the near future. Management said this year’s payout ratio could be outside the target range of 35% to 45%. But the dividend is still well covered by the company’s free cash flow. I think it may even have room to grow as the environment stabilizes.
Share buybacks are also important. The company has repurchased more than a quarter of its shares in the past five years. Management has suspended redemptions for the time being. But they have shown a willingness to use buybacks to generate high returns for shareholders.
I’m surprised by Best Buy’s strong fundamentals. The company has a strong moat and its balance sheet is very healthy. The cheap valuation should provide some margin of safety.
Due to the high uncertainty, I think there could be other downsides. Now may not be the right time to buy stocks. But with the current free cash flow performance, I think it makes sense to start a small position.