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Best Buy Co., Inc.

3-D TV to Draw Curious Customers?

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The 2009 liquidation of Circuit City after its bankruptcy has significantly changed the competitive landscape in the $166 billion consumer electronics industry. For one thing, Circuit City’s departure reinforced the position of Best Buy Co., Inc. (ticker: BBY) as the world’s largest consumer electronics retailer.

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The demise of a major competitor isn’t the only positive development for Best Buy. The company is expected to derive long-term benefits from its aggressive overseas expansion, noted members of BetterInvesting’s Editorial Advisory and Securities Review Committee. And the recent introduction of a high-definition 3-D television could lead to increased store traffic as consumers satisfy their curiosity about the new technology, members suggested.
The company continues to innovate, experimenting with new merchandise lines and retailing concepts. That adaptability is a major part of management’s strategy as competition in consumer electronics continues to heat up at both ends of the spectrum.
Small regional chains moving to fill the Circuit City vacuum could represent long-term challenges, for example. Big-box discounters such as Wal-Mart, Sears, Target and Costco are expanding their consumer electronics offerings. Amazon.com caters to the growing number of consumers who prefer to purchase electronics online.

Background Briefing

The company sells consumer electronics and related products through its Best Buy stores and other retail outlets in the United States, Canada, China, Europe and Mexico. In the domestic market, the heaviest store concentrations are in California, Texas, Florida, Illinois and New York.
The consolidated sales breakdown for fiscal 2008 was as follows:

•  Consumer electronics — 36 percent
•  Home office — 34 percent
•  Entertainment software — 17 percent
•  Appliance — 6 percent
•  Services— 7 percent
Over the past year the company has expanded significantly, tripling its worldwide store count. Much of the growth in the number of outlets resulted from its Best Buy Europe joint venture.
In fiscal 2008 (ended Feb. 28, 2009), the company was operating 3,953 stores of all types worldwide. Of these, 1,023 — 25.9 percent — were outlets located throughout the United States, except for Wyoming.
(Value Line labels the year ended Feb. 28, 2009, as fiscal year 2008. Best Buy opts to call the period fiscal 2009. Value Line’s definition is used throughout this article.)
Although domestic Best Buy stores and the company’s other U.S. outlets now represent only a quarter of the individual locations worldwide, they still generate most of the company’s results. Domestic outlets represented 75.4 percent of the company’s 54.3 million square feet of selling space in fiscal 2008. U.S. sales were 78 percent of the 2008 total.
Over the past nine years Best Buy has acquired or launched several chains complementing its core business. In 2007, for example, Best Buy acquired Pacific Sales, which specializes in high-end kitchen appliances, plumbing fixtures, home entertainment products and home furnishings. The chain comprised 34 West Coast stores in fiscal 2008.
Another unit is Magnolia Audio Video, acquired in 2001. The chain retails high-end entertainment merchandise in its six West Coast stores.
In 2003 Best Buy acquired the Geek Squad, a Minneapolis-based service business. Its employees provide residential and commercial customers with on-site electronics repair, support and installation. The service is available in Best Buy stores, as well as in six stand-alone locations.
In 2002 Best Buy acquired Future Shop. It’s the leading consumer electronics retailer in Canada, with 139 stores at the end of fiscal 2008. The company also had 58 Best Buy outlets in Canada that year.
One of Best Buy’s innovations is its store-within-a-store concept for marketing distinct product categories. Best Buy Mobile, for example, sells mobile phones, accessories and related merchandise inside Best Buy stores. In fiscal 2008 there also were 38 stand-alone Best Buy Mobile outlets, more than quadruple the number open in mid-Atlantic locations the year before.
Best Buy launched the unit in 2006 when it began working with The Carphone Warehouse, a British company that has become Europe’s leading retailer of mobile devices. The next year the two companies formed Best Buy Europe. The joint venture had 2,465 overseas locations at the end of fiscal 2008.
Near the end of 2008 the company completed its acquisition of Jiangsu Five Star Appliance, a major Chinese retailer with 164 stores. The company is also operating five Best Buy stores in that country.
In fiscal 2007 Best Buy acquired Napster, a well-known music downloading service. Similarly, the company recently acquired a stake in CinemaNow, a movie downloading service. The deals provided Best Buy with a way to maintain a position in entertainment media despite declining sales of CDs, DVDs and entertainment software.
Yahoo! Finance reports that Best Buy’s chief direct competitors are publicly traded Apple Inc. (AAPL), Amazon.com (AMZN) and Wal-Mart Stores (WMT). Other challengers are hhgregg and P.C. Richard, two rapidly expanding regional chains that in some cases are moving into territories formerly served by Circuit City. Additional competition comes from wholesale clubs, office supply chains and mail-order and Internet retailers.
Standard & Poor’s classifies Best Buy as a computer and electronics retailer. Publicly traded companies in that category include GameStop (GME), Glentel (GLN), RadioShack (RSH) and Rex Stores (RSC).
Best Buy’s roots go back to 1966, when Richard M. Schulze launched Sound of Music, an audio components retailer. As the chain expanded beyond the Minneapolis area, it added categories of consumer electronics merchandise. The company adopted its current name in 1983 and went public in 1985.
Schulze, 70, remains chairman. Brian J. Dunn, 49, is CEO, president and chief operating officer. Dunn, who joined the company in 1985, became its leader in June 2009. He took over from Bradbury Anderson, who retired.
Schulze held 17.1 percent of 418 million common shares outstanding, the company reported in its May 2009 proxy statement. He and other officers and directors combined owned 19 percent. Institutions recently held 73.5 percent, according to Value Line.

Retailing Innovations

In March Best Buy began carrying Panasonic’s new 50-inch 3-D television system. The technology, which has gained popularity in theaters, is just now becoming available to consumers. Major television manufacturers Sony, Samsung Electronics and LG Electronics reportedly plan to launch their own versions.
Although heavily discounted, the Panasonic systems remain costly at about $2,500. Analysts therefore predict 3-D television may be slow to add much to Best Buy sales. But with no other revolutionary, “must have” consumer electronics arriving soon, 3-D may at least get curious but wary customers into the stores.
In its efforts to adapt continually to industry changes, Best Buy tests how well consumers accept new merchandise offerings. For example, the company has begun selling patio furniture, grills and related outdoor merchandise through its website. In a test, a few California outlets are stocking the products.
Another new category is electronics related to exercise and health care. Forty stores recently began stocking portable heart rate monitors, pedometers, headphones and conditioning accessories. Some of the outlets are also selling exercise machines.
Last year the retailer began selling used video games out of kiosks set up in several Texas and Canadian stores. And Best Buy is continuing its market test of musical instruments and related electronics. Some stores are carrying items such as guitars, keyboards, software and accessories.
In another recent departure from consumer electronics, Best Buy has begun selling Enertia battery-powered motorcycles. About two dozen West Coast stores participated in the initial test, and Best Buy reportedly plans to market the vehicles in more states this year.

Final Notes

Value Line, the source for the financial results in this article, reports adjusted quarterly earnings per share but not quarterly net income. For diluted EPS, the Value Line and company-reported figures match for third-quarter 2009 and the year to date. The company-reported figures for 2008 were considerably lower, however. Valid year-over-year comparisons of net income therefore can’t be made.
Note that the partially completed Stock Selection Guide shows the range of calendar-year market prices, which are taken from the Value Line report. In contrast, BetterInvesting’s S&P Stock Data Service provides fiscal-year pricing data. Here are the rounded fiscal-year price ranges for the past five years:

•  $29.20 to $41.50 (fiscal 2004)
•  $31.90 to $56.00 (fiscal 2005)
•  $43.50 to $59.50 (fiscal 2006)
•  $41.90 to $53.90 (fiscal 2007)
•  $16.40 to $49.00 (fiscal 2008)
The goal for a Stock to Study is a 100 percent return (market price appreciation plus dividends) within five years. BetterInvesting is profiling Best Buy for educational purposes only. No investment recommendation is intended.
BetterInvesting featured Best Buy as the Undervalued Stock for January 2009. The company ranked No. 74 in the Top 200 survey of investment club holdings for 2009 (see the April 2010 issue). An estimated 307 clubs owned its shares.
The company instituted 3-for-2 stock splits in 1987, 1993, 2002 and 2005. Shares underwent 2-for-1 splits in 1986, 1994, 1998 and 1999. Best Buy has instituted a direct stock purchase as well as a dividend reinvestment program.
Internet links to background on Best Buy and its industry can be found in the online version of this article at the BetterInvesting website. To request more information, contact Investor Relations, Best Buy Co., Inc., 7601 Penn Ave. S., Richfield, MN 55423-3645.

SSG Notes

During your analysis of Best Buy, you might consider the following comments and questions for further study:

•  Capitalization section: About 19 percent of Best Buy’s stock is owned by insiders. That’s a high percentage, indicating that management’s interests are aligned with those of other shareholders. Note, however, that one person — company chairman Richard Schulze — accounts for the vast majority of those insider holdings. Best Buy’s percentage of debt to total capital stands at almost 29 percent. Value Line projects that the company’s long-term debt will drop to $600 million in 2012-2014 from about $1.1 billion currently; it has assigned a Financial Strength rating of A to Best Buy. Value Line also estimates that current common shares outstanding will continue falling from historical levels over the next several years. If you use the Preferred Procedure to estimate future earnings per share, how will this history affect your forecast?

•  Section 1 (Visual Analysis of Sales, Earnings and Price):   Best Buy’s historical sales growth looks quite steady, as does earnings growth except for last year. The stock price, however, has experienced significant fluctuation in several years — 2000 to 2003, for example, along with 2008.

•  Section 2 (Evaluating Management): The pre-tax profit margins appear low compared with companies in other industries, but how does Best Buy stack up with other retailers? The margins themselves were steady in 2003-2007 before falling in 2008. Return on equity has grown over the past five years. Note, however, that Best Buy added debt in 2008. This can inflate ROE.

•  Section 3 (Price-Earnings History): The high P/E was above 20 in 2004, 2005 and 2006 before dropping to 17-18 in 2007 and 2008. How will this affect your expectations of the high P/E in future years?
Websites of Interest

Best Buy Co., Inc.
Consumer Electronics Association

The Editorial Advisory and Securities Review Committee met March 26. The Stock to Study and Undervalued Company that its members selected were announced shortly afterward. Look for the Stocks to Study box on the right-hand side of the homepage. The link takes you to the announcement at the BetterInvesting Newsroom (www.betterinvesting.org/
— Reporting by contributor Kevin Lamiman

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