Story Behind 22% Rise in Best Buy Shares

It’s almost amusing. In the case of other retailers, a report that their domestic same-store sales were flat in November and December – the height of the holiday shopping season and during which retailers log the single largest portion of their annual sales and profits – while international sales plunged more than 6%, would have ignited a selloff in the company’s stock. In the case of Best Buy (BBY), the news has triggered a rally that has left the shares more than 22% higher than where they traded two weeks ago, at the beginning of 2013, with the bulk of that gain – a 16% one-day rally – taking place on Friday in immediate response to the news, as seen in a stock chart.

BBY Chart

BBY data by YCharts

But investors didn’t stop to reflect over the weekend, and think twice about their newfound enthusiasm for the troubled electronics retailer, as they should have done. It isn’t just that sales were flat, it is the fact that to convince anyone to place an order online or shop in person, Best Buy had to keep matching prices offered on its products by rivals with deeper pockets, namely Amazon (AMZN). All of the figures are there for investors to ponder: the fact that restructuring charges for the first nine months of 2012 already totaled $250 million (much of it related to the costs of shuttering U.S. retail outlets), and the downward revision in the company’s own cash flow projections.

BBY Free Cash Flow TTM Chart

BBY Free Cash Flow TTM data by YCharts

That cash flow revision is particularly important. Best Buy now is expecting its cash flow for 2012 to total a mere $500 million, down from the range of $850 million to $1.05 billion it announced only two months ago. That signals that in order to book those flat same-store sales results, Best Buy annihilated its own profit margins.

The question here is whether Richard Schulze, Best Buy’s founder and former CEO, can get funding from private equity backers and the debt markets for a proposed buyout. An offer from Schulze – if it comes at all – is likely to arrive next month, within days or weeks of the company’s fourth-quarter earnings announcement. And it’s hard to imagine that a buyout fund manager looking at the steep decline in cash flow would be eager to sign up to finance this deal; after all, new debt incurred to fund such a buyout would need to be financed from that cash flow. And as the chart below shows, while the company’s debt level has climbed modestly in the last three years, its margins and cash flow from operations have plunged.

BBY Profit Margin Quarterly Chart

BBY Profit Margin Quarterly data by YCharts

Nor can Best Buy count on improving economic indicators or a sudden surge in demand for its electronic goods to improve the outlook. When rumors of disappointing sales haunt even the hyper-profitable Apple (AAPL), it’s mightn’t be a good time to challenge the prevailing wisdom by deciding that Best Buy, somehow, will buck the industry-wide trend. Consumers want bargains, and the only way Best Buy can deliver them is to relinquish profits.

Odds are that what has taken place is that short sellers have rushed to cover their positions and get out of the stock, and that momentum investors and traders are jumping on board the proverbial bandwagon. Gimme Credit, the debt rating research firm, says the latest efforts at a turnaround program could be “too little too late.” Moreover, analyst Carol Levenson argues, real cash flow may not even cover the company’s recent share buybacks, meaning net debt will edge higher. Sure, the company may still have a decent balance sheet, but it’s hard not to agree with Levenson’s conclusion that the company’s fundamentals are deteriorating. This rally may well prove to be more of a false dawn than a new day for Best Buy.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.

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