Please excuse me for sounding like a broken record, but in
, you need to look at adding stocks with a high
margin of safety
to your portfolio. The S&P 500's stunning six-month surge
should have you thinking about capital preservation as much as
Simply put, it's hard for me to get behind a stock that has already
had a strong recent run, knowing that a shift in the market mood
could leave me holding the bag if profit-taking kicks in.
This isn't to suggest that poorly-trading stocks are the only ones
that hold appeal. Indeed many of these relative duds are likely to
while they address internal operational challenges. Yet even in
this group, you need to scour the landscape for potential gainers.
In that light, I was pretty intrigued to read a recentbullish
report by Credit Suisse on beleaguered retailer
Best Buy (NYSE:
. This consumer electronics chain should have benefited from the
demise of bankrupted rival Circuit City, but instead saw its own
recede in the face of
Best Buy's sales grew just 0.1% in fiscal (February) 2011 to $49.8
billion, and just 1.9% in fiscal 2012 (to $50.7 billion).
Considering employment levels look better than they did a year
earlier, that's pretty anemic growth. Perhaps even more damning,
Best Buy is making lessprofit on each sale.
margins have historically hovered in the 6% to 7% range, but fell
to just 4.1% in fiscal 2012.
Yet even with those dismal metrics, Best Buy is a
. The retailer generated a hefty $2.5 billion in
in fiscal 2012. That's more than the prior three years combined. In
effect, this isn't a broken business, just one that needs some
resuscitation. More to the point, that prodigious free cash flow
gives a booster shot in terms of valuation support: Best Buy is
valued at less than $9 billion on an
basis, meaning its free cash flow
is 27% ($2.5 billion / $9 billion = 27%).
I'm not the only one who sees the potential here. Credit Suisse's
Gary Balter sees roughly 35% upside to his $32
even as he takes management to task. First, he thinks the retailer
is mistaken by treating its stores and its website as distinct
entities. Retailers such as Wal-Mart and
are doing a much better job of leading customers to focus on both
sales channels, allowing one effort to
He also says management remains a bit myopic in trying to address
weak same-store sales trends. The company recently announced it
would close 50 of its 1,100 stores, and analysts say it should
close more. Balter even suggests Best Buy move more quickly to
close marginally profitable stores and reinvest funds and energy
into improving remaining stores.
Yet Balter gives credit where it's due. "It would be unfair to
imply management is fiddling. They have made some brilliant moves,
growing BBY Mobile, shutting China and Europe large stores, growing
private label, etc... but our comment above is that they can do
To be sure, many investors think Best Buy is in the midst of a
long-term decline, as super-efficient retailers like Amazon will
never relent on price. Yet Balter thinks Best Buy remains as the
"largest of its breed" and does not have to become a dinosaur.
In fact, profit-sapping price wars between Best Buy and Amazon and
Wal-Mart may eventually sharply diminish. Samsung and
announced a new policy on April 1 that forces all retailers to
adopt a unilateral pricing policy on many higher-end TVs. "Our
ongoing pricing study shows that the policy is helping BBY close
the pricing gap with AMZN on televisions in general," notes
Deutsche Bank's Mike Baker. That gap stood at 7.3% in mid-March,
but is now 3.5%.
Risks to Consider:
Amazon goes for the jugular when it senses a rival has been
weakened. Best Buy remains in a very strong financial position, but
that still may not stop Amazon from adopting irrational pricing
just to beat out Best Buy.
Action to Take -->
I like this analyst'scall a lot. He's correct in noting that Best
Buy's management deserves more credit than it has been getting. And
the stock's current valuation borders on the absurd. While the free
cash flow yield remains around 27%, Best Buy should be buying stock
back at a prodigious clip. Balter's $32 price target isn't all that
aggressive, as it equates to just nine times the consensus fiscal
forecast of $3.60 per share. (The fact that the stock currently
trades for just seven times that forecast is another point for the
I also like Best Buy for a far more prosaic reason. Even assuming
zero improvement in this
strength and a stock price below $24 offers tremendous downside
support. That's a key consideration in today's fast-rising
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.