Description

Best Buy (Ticker: BBY) is a multi-channel retailer that sells a variety of technology and electronics products, including computers, phones, printers cameras, stereos, appliances, and much more. The company’s purpose is “to enrich the lives of consumers through technology.”

The company has ~125,000 employees who service a substantial bricks and mortar presence (~1,200 large format and ~55 small format stores), and a significant online platform that has expanded rapidly during the pandemic. With an EBIT/TEV yield of 8.3%, we think BBY is relatively cheap at these prices, given its economic moat and the sustainable competitive advantages discussed below.

BBY is obviously not Amazon. But they have shown an ability to adapt, they have a unique customer service model that AMZN can't easily replicate, and the valuations are obviously very different.

For an example of how adaptable BBY’s business model is to changing business conditions, consider the company’s response to the pandemic.

Response to the Pandemic

In March, as the pandemic hit during the company’s first fiscal quarter (ending May 2), BBY moved to a contactless, curbside-only operating model. During May the company began lettering customers return to stores by appointment, and by late June, nearly all of the company’s stores had been reopened for shopping.

BBY is mainly a bricks-and-mortar retailer, so you would expect it would get hit hard by the pandemic. Yet, for the company’s most recent fiscal quarter (Q2 ending 8/3/20), when the pandemic was still impacting many store-based retailers, BBY actually grew their revenues by 3.9% compared to the prior year’s Q2. How? This impressive result was driven by the company’s pivot to online sales, defined as sales initiated on a website or app, regardless of how product was ultimate obtained by the customer (e.g., pickup, curbside, alternate location, direct delivery, etc.).

The company’s domestic online revenue skyrocketed to $4.8bn during Q2 of Fiscal 2021, as compared with $1.4bn during Q2 of Fiscal 2020 – a staggering YoY growth rate of approximately 240%. In other words, online growth more than offset the loss of foot traffic at the stores, and even as the stores reopened, online sales continued surging. It is notable that for this most recent Q2, online revenues were 53% of total revenues, up from 16% for the comparable quarter in the preceding year. If you ask us, that’s pretty incredible.

Customer Service

We argue BBY’s competitive advantage that enabled this pivot was its customer service component. And BBY’s customer service platform is impressive (confirmed via personal experience).

People often think of hardware / technology as a commodity product. But the reality is often more nuanced. Sometimes people don’t know what they want. Sometimes they would choose differently, or might want something completely different, if they had a better understanding or, say, different fulfillment or installation options. Sometimes they want someone to hold their hand and get them set up properly so they can immediately begin using their new products.

You may be familiar with Geek Squad, which assists with delivery, setup, troubleshooting, ongoing support and repair. But there is also Total Tech Support membership, which offers unlimited support for tech products and covers standard services such as TV mounding and Wifi setup, and extends to things like heavy repairs or wiring of security cameras. Then there’s GreatCall, which offers connected health and emergency response services for seniors. And of course, in-store, phone or digital in-home consultations and installation involve products from products from multiple vendors, which provides customers with a broad set of options.

These services enable the company to take advantage of the demand for sophisticated tech and electronic hardware and devices, by leveraging customers’ desire for consultation, and installation services, and flexible deliver and pickup. Each interaction is a chance for BBY to build trust and a customer relationship that drives repeat transactions.

This is fundamentally what BBY does: it helps consumers understand how best to integrate technology in their lives.

Say you want to physically inspect your electronics before buying, get some in-person consultation from an expert, or walk out of the store with your product; at BBY, you can do that. What if you want to buy it online but pick it up that day at the store, and also have access to in-person technical support, or even someone to visit your home, so that you can get it to work quickly? Also possible.

The point is there is tremendous flexibility and extensibility of the offer. BBY primarily sells hardware, but more importantly it tailors technology to the customer, and the customer’s specific needs, and in so doing builds a relationship with that customer.

We argue that this differentiated, integrated product/service offering is a sustainable competitive advantage that supports BBY’s moat. We like to look at several long-term measures that capture the persistence and effectiveness of these moat characteristics.

Fundamentals

The first two are long-term (8 yr) geometric returns on assets and on capital. Firms with economic moats tend to have high long-term ROA and ROC.

For BBY, long-term (8 yr) return on assets was 7.2%, placing it in the top third of our investable universe of stocks. BBY’s long-term (8 yr) return on capital was 16.3%, which puts it in the 86th percentile of our universe.

BBY has generated substantial FCF relative to the asset base over the past 8 years.

Over the past 8 years, BBY has had quite stable gross margins, which have ranged from 22.1% to 23.8% over that period. The consistency of BBY’s margins demonstrate it has had strong pricing power over a long period, and has successfully kept control of supplier input costs.

Operational Momentum

Despite the pandemic, BBY seems to be showing significant financial strength and operational momentum. The company’s current ratio has increase in the past 12 months, as compared with the prior year, indicating improving near-term liquidity. BBY’s leverage ratio, defined as debt/assets, fell in the past year.

BBY’s LTM ROA was 10.4%, an increase over the prior year’s ROA of 10.1%. BBY’s ROC increased to 21.6%, up from 20.4% in the prior year. LTM FCF was over $5 bn, and a significant increase from the prior year. Additionally, BBY was a net repurchaser of equity, although the company has paused buybacks during the pandemic.

In our view, BBY’s economic moat, consisting of its multi-channel integrated product, customer service and fulfillment offering, has served BBY well during the pandemic, enabling it to adapt to changing market conditions. We believe the flexibility and adaptability inherent in this model will continue to serve the company well going forward, and will enable continue high returns on capital and assets, stable margins and significant free cash flow.

In sum, BBY is not cheap on an absolute basis (nothing is at the moment!), but at an EBIT/TEV yield of 8.3%, we find BBY shares attractive relative to other inestments in the current environment.

Catalyst

- Continued evolution of the customer service offering that differentiates the company

- Continued high returns on capital and assets

- Continued pricing power and stable margins