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Stock Analyst Update

Best Buy Executes Well, but Shares Overpriced

While we see the attraction in the retailer's shareholder-return story, the market continues to price in top-line growth and margins that seem like a stretch even for one of the most improved retailers.

Mentioned:

 Best Buy (BBY) is clearly executing at a level well ahead of most retailers, evidenced by fourth-quarter comps of 9% and tactical pricing and product measures that preserved domestic gross margins (flat at 22.3%). Some tailwinds were in play--iPhone X launch and Super Bowl timing; smart home, wearables, and gaming product cycles; and competitors exiting certain markets--but we share management's views about results being more about execution than external factors. As we've said in the past, management deserves credit for improving Best Buy's relevance, and while we're not ready to assume a fiscal 2021 revenue target of $43 billion, we think a range between $42 billion and $43 billion is realistic (even after factoring in the closure of all 257 mobile stores in May). This also makes a goal of $1.9 billion-$2.0 billion in operating profit (implying 4.5% operating margins) and revised EPS target of $5.50-$5.75 (up from $4.75-$5 due to lower effective tax rates) for fiscal 2021 reachable.

Despite the strong quarter and reasonable expectations for fiscal 2019 (revenue between $41 billion and $42 billion, 0%-2% comps, operating margins of 4.5%--flat versus fiscal 2018--and adjusted EPS of $4.80-$5), we still see a disconnect between the stock's valuation and our longer-term assumptions. We plan a moderate increase in our $48 fair value estimate based on current trends and time value of money, but still see 0%-1% comps and operating margins peaking around 5% before contracting amid industry consolidation/competitive pressures across new products and in-home services (the rationale behind our no-moat rating). While we see the attraction to Best Buy's shareholder-return story (including a 32% increase in its annual dividend to $1.80 and $1.5 billion in buybacks planned this year), we believe the market continues to price in low- to mid-single-digit top-line growth and 6% margins over an extended period, which seems like a stretch even for one of the most improved retailers./p>

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R.J. Hottovy does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.