What About Consumer Electronics?

The business of retail consumer electronics is incredibly competitive; there are very few big companies involved in that domain and not too many of them manage to be profitable on a consistent basis. This is very intriguing to me since, according the firm Euromonitor International, the amount of sales of that industry in North America amounted to $147 billion in 2008 and that the market has been growing on average by 8% a year during the five years going from 2003 to 2008. That same market of consumer electronics is very interesting since the giant company Circuit City (OTC: CCTYQ) went on a bankruptcy fire sale, thus leaving more room for the remaining competitors.

Here is a quick snapshot of the company; according to their official documents, Best Buy Co., Inc. (NYSE: BBY), incorporated in 1966, is a specialty retailer of consumer electronics, home office products, entertainment software, appliances and related services. The Company operates retail stores and Web sites under the brand names Best Buy, The Carphone Warehouse, Five Star, Future Shop, Geek Squad, Magnolia Audio Video, Napster, Pacific Sales, The Phone House and Speakeasy. It operates through two business segments: Domestic and International. The Domestic segment consists of the store, call center and online operations in all states, districts and territories of the United States operating under the brand names Best Buy, Best Buy Mobile, Geek Squad, Magnolia Audio Video, Napster, Pacific Sales and Speakeasy. The International segment is comprised all Canada store, call center and online operations, under the brand names Best Buy, Best Buy Mobile, Future Shop and Geek Squad. Its International segment offers products and services similar to that of its U.S. Best Buy stores. On June 28, 2008, the company acquired a 50% stake in Best Buy Europe. On October 25, 2008, the Company completed the acquisition of Napster, Inc.

As of February 28, 2009, the Company operated 1,023 U.S. Best Buy stores, 38 U.S. Best Buy Mobile stand-alone stores, 34 Pacific Sales stores, six Magnolia Audio Video stores, and six Geek Squad stand-alone stores, totalling approximately 40.9 million retail square feet. As of February 28, 2009, the Company operated 897 The Carphone Warehouse stores, 1,568 The Phone House stores, 58 Best Buy Canada stores, three Best Buy Mobile Canada stores, 139 Future Shop stores, five Best Buy China stores, 164 Five Star stores and one Best Buy Mexico store totalling approximately 13.3 million retail square feet.

The dominant position of Best Buy Co. in North America in the consumer electronics market is pretty obvious, and it led me to think that this was their main competitive advantage in that business. However, after taking a look at their financial statements, things got more interesting.

First, their 42% debt to equity ratio is very decent compared to the 83% of the industry or the 131% of S&P500 companies; such a low level of leverage is one of the main reasons why the company continues to be profitable even in these difficult economic times. The preeminent thing is that consumer durables are usually the products that are hurt the most in a recession! They also managed to extract a 24% return on equity from their business, which is more than double of the 12% achieved by the rest of the industry.

There seems to be a catch though, their profit margin of 2.3% is incredibly low... that means that for every $100 of revenue, only $2.30 turned into profits, compared to the $12.20 average generated by S&P500 companies. Such a fact is really the persistent downside of the retailing business, big sales volumes doesn’t necessarily mean hefty profits.

In my mind, Best Buy remains the most interesting long-term play in the consumer electronics business and, everything being equal and assuming there were no better opportunities available, I would definitely buy it as long it is priced under 39$ per share to ensure a sufficient margin of safety. Take note that my long term price target does not take future stock-splits and dilutions into account

Full Disclosure: The author does not have a position in BBY.
10-year target selling price per share: 153$