We're pressing our BBY short after an earnings report that capped off the best year that the company ever reported -- by a country mile. Yes, BBY missed by a penny and comp fell short by 200bps, but relative to what we expect to see over the longer-term, it was a solid quarter. We don't think we'll see these levels of profitability per share again for another 5-years -- and that will likely be driven by stock repo (about $7bn worth) as opposed to EBIT growth, the repo being the highlight of this story as it stands today. Even as far out as Fiscal '25, we've got $7.71 in EPS power, which compares to the Street at $11. In order to get to $11 we have to assume that BBY pushes to a new high peak margin rate, or we see an outsized comp cycle -- neither of which we think is prudent to bank on.
The company made it clear in its actions to cut employee count, and step-up store closures over the next three years that the shift to digital shopping is permanent, and is likely to remain at about 40% of BBY sales. No ifs, ands, or buts about it…this is Gross margin dilutive. In the fourth quarter, for example, the GM% rate was negatively impacted by 50bps (a big deal when you're at a 6% EBIT margin rate) due to the shift to online fulfillment. In addition, extended warranties are ~40% of EBIT, and they see a lower attachment rate when product is purchased anywhere but in-store. There's further gross margin pressure. The company has recognized $500m of its $1bn in cost savings planned by 2025. That gives about an incremental point in margins as a pad over a TAIL duration -- but this should be more than whittled away by the shift to digital. Add wage pressure on top of that (raised min wage to $15 and have avg hourly wage to $17.67), and it rests solely on the comp line to drive the EBIT growth algorithm.
But comp challenges are clear. The company is being innovative in investing in Health Technology to drive the top line, but we don't think it's enough to offset the monumental comp hurdle from 2020. Our view is that BBY is likely to see an air pocket in demand from the housing, WFH and School from Home boom in 2020 that will pressure sales over the next two years. Financials in 2H should look particularly rough, with an estimated 7% comp decline, GM pressure due to online shift, warranty pressure and increased marketing expenses. If we're right, then we're looking at EPS of $6.63 vs the Street at $7.45. If we're right in our model, we think that BBY will get a 10x multiple in a downward earnings revision cycle -- or a $65 stock -- that's 35-40% downside from current levels. It's stunning that the short interest on this name remains near an all-time low of 2.8%. Best Buy remains a Best Idea Short.
