We plan to ratchet up our $44 fair value estimate, and see shares as modestly overvalued today.
By R.J. Hottovy, CFA | 08-29-17 | 02:21 PM | Email Article

Although  Best Buy  offered investors one of the rare bright spots in an otherwise tepid retail reporting season, the market appears more concerned that the company's strong second-quarter results--including comps of 5.4%--are not sustainable.

R.J. Hottovy, CFA, is a consumer strategist for Morningstar.

Domestic comps were positive across the board as the retailer continues to benefit from not only positive consumer cycles in computing, wearables, smart home, and gaming hardware/software (Nintendo Switch), but also its own customer service and multichannel efforts, which helped drive 31% online sales growth.

We believe mid-single-digit comps are achievable in the back half of the year--we expect comps toward the high end of Best Buy's 4.5%-5.5% outlook in the third quarter and low- to mid-single-digit growth in the fourth quarter--due to momentum in the aforementioned categories and upcoming smartphone launches (iPhone 8, Samsung Note). However, CEO Hubert Joly's comment that "mid-single-digit comps are not the new normal" squares with our outlook calling for low-single-digit comps over a longer horizon as current product cycles normalize, the industry consolidates, and vendors increasingly take products directly to consumers.

Management deserves a ton of credit for making Best Buy more relevant to vendors (stores within stores) and consumers (improved multichannel capabilities) while continually finding ways to re-engineer its cost structure. We're also intrigued by the upcoming Best Buy 2020 investor day, where management plans to emphasize service and multichannel capabilities, which should help from a competitive standpoint but not enough to change our no-moat rating, given similar endeavors by Amazon and other mass merchants. We plan to ratchet up our $44 fair value estimate by a few dollars to account for the second-quarter upside, but we continue to expect operating margins to peak around 5% over the next few years and view the shares as modestly overvalued at current levels.

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R.J. Hottovy, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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