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Best Buy: As Pathetic as Sears, JCP (Updated)

If you have read my work at TheStreet and stream of (un)consciousness on Twitter (TWTR) for more than a minute, you know I don't think much of the culture of Wall Street analysis. However, there are a few guys I read almost religiously. Michael Pachter at Wedbush is one of them. 

However, I have to admit, I have been remiss in that Pachter has had a sell rating on BBY for quite some time. Now, on one hand, as the game gets played on Wall Street, that's not a good thing, given the stock's appreciation. That's why I'm bearish Netflix (NFLX) the company, while maintaining a bullish position on the stock since Summer 2012. But Pachter deserves credit as well as your attention. His analysis of BBY -- and NFLX for that matter -- is spot on. 

What follows is his take, word-for-word, on the Best Buy post-holiday crash. I pull the most important bullet point first ... the line about Internet sales versus overall sales. So crucial. Then I reprint the note in its entirety ...

Management pointed out the bright spot that Internet sales were up roughly $200 million, while overall domestic sales declined by roughly $150 million. This implies that overall store-level sales declined by $350 million during the holiday period, triggering massive deleverage. This is not a bright spot, in our view.

Cuts through the almost Reed Hastings-like smoke and mirrors getting thrown down at Camp Viva Joly!

Here's the entire summary of the note:

Before the market open Friday, Best Buy reported holiday sales results (9-weeks ending January 4), with comps down 0.8% (down 0.9% domestically, up 0.1% internationally), below our estimate of up 0.5%. Domestic growth in computing, appliances and gaming were offset by declines in digital imaging, movies, and MP3 players. International revenues decreased due to store closings and negative FX headwinds, but experienced slightly positive comparable store sales. Best Buy hosted a call today and will announce Q4:14 results on Feb. 27.

Best Buy attributed domestic comps declines to the promotional environment leading to deflationary sales, supply constraints in the tablet and mobile phone categories, significant store traffic declines, and a disappointing mobile phone market. Management pointed to NPD Group's revenue for the CE industry down 2.4%, while Best Buy's CE domestic comp of down 6% implies to us market share losses to online competitors.

Best Buy now expects Q4 operating margin to decline 175 to 185 basis points year over year vs. 40 to 70 basis points prior. The degradation in margin was due to incremental discounting to defend market share. We expect price competition to continue, and expect lower operating margins for three quarters.

Must Read: The United States of Google

Management pointed out the bright spot that Internet sales were up roughly $200 million, while overall domestic sales declined by roughly $150 million. This implies that overall store-level sales declined by $350 million during the holiday period, triggering massive deleverage. This is not a bright spot, in our view.

We are decreasing our Q4:14 estimates for revenue to $14.8 billion from $15.0 billion and our EPS estimate EPS to $1.06 from $1.41 to reflect holiday results.
We are lowering FY:15 estimates for revenues to $42.0 billion from $42.2 billion and EPS to $1.69 from $1.79, which excludes $320 million of restructuring.

We are reiterating our UNDERPERFORM rating and 12-month price target of $18. Our target is based on an EV of 10x sustainable free cash flow, reflecting expected negative comps in 2014, further margin erosion, low visibility, lack of guidance, and doubts about the sustainability of Best Buy's turnaround plan. We expect comps declines to continue, and we expect price matching to continue to pressure margins.

Pachter's price target on BBY is $18.00.

If you don't realize it yet, soon you will -- you're watching the long slow decline of physical retail and Best Buy, even if it considers itself well-intentioned and on the proper path, isn't doing a darn thing to stop it. 

--Written by Rocco Pendola in Santa Monica, Calif.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks. Rocco Pendola is a columnist for TheStreet. Whenever possible, Pendola uses hockey, Springsteen or Southern California references in his work. He lives in Santa Monica.
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