A strong quarter for BBY. Headline EPS came in over a dollar ahead at $2.98 vs $1.89 though with 47 cents in one time tax benefit. Comps of 20% vs street at 17% slowing vs last Q about 350bps on a 2 year basis. The company is guiding up 2H comps with some corresponding margin upside. It’s out of character for BBY to give an upward revision like this liking to keep near term expectations low, that perhaps explains the stock reaction. Though even with the guide up revenues are still to be flat to down in 2H, and top end of guide implies another 200bps slowdown in 3Q (similar to the current QTD flat vs +20% QTD last year) and likely further 2 year slowdown in 4Q. That means from 1Q to year-end comps could slow nearly 1000bps on the 2 year trend with the compares are steepening significantly. There’s a lot of leverage in the model in terms of EPS with comp strength like we saw this Q, but the deleverage can be just as powerful. 1H23 (22 calendar) will see very difficult compares from both a revenue and promotional perspective. Given the elevated levels of consumption for BBY categories over the last year or so, and the long replacement cycles of many of these core items, we continue to expect to see an air pocket in demand. Perhaps the slowing 2 year trend is that process starting at a slower rate than we previously expected.
On the margin side, credit has been reverting positively this year with a drag from over reserving last spring/summer. So that tailwind dissipates in a quarter or two. In addition we expect some margin pressure from lower extended warranty conversion due to higher post covid online penetration, which is amortized over the product life. We think Best Buy Beta membership is a way to try to offset the conversion risk around warranty and support services, rather having it done via subscription. It makes sense to try such a program, we just don’t think there will be enough customers willing to pay the price tag vs those who used to get an extended warranty at checkout with the salesperson’s advising it. Maybe lapping freight spikes could present some small margin opportunity, but that doesn’t look like much of a retail tailwind for the foreseeable future. We expect the demand air pocket to really rear its head in fiscal 1H23 (Jan) lapping stimulus and heavy FY2022 consumption, that means sales down materially while still feeling inflationary pressures including wages and advertising for big SG&A deleverage risk. While we expect the categories to weaken, promotional intensity likely picks up more, though at the moment we see more risk on SG&A deleverage than GM pressure into early 2023.
This company is at peak sales, peak margins, peak earnings on peaked category demand. Forward annualize earnings will undoubtedly be going down on a YY basis. This is looking like a cash return story with recently elevated buyback and a dividend. Sales are inflecting negatively, with margins peaked, so we don't think this should be trading at near peak EV/sales and above average historical PE levels. The updated guide puts FY2022 around $10.25, vs LTM $10.75 (both with the tax help this Q). Consensus numbers are going up, NTM likely to be around $9. So the market is giving that nearly a 14x PE on a declining earnings base. Given the peak in the rearview mirror, the “right” margin here is hard to say. We think there is risk to NTM EPS being as low as ~$8.10 if the first half sees the deleverage risk we think is possible. We think BBY can see a PE around 10x or lower on a declining earnings base with the downward revision risk in 2022. That would suggest a stock around $80 or about 35% downside from here. BBY remains a Best Idea short.
Consensus numbers likely going higher, guidance used for 2022 EPS.
