The Secret To Best Buy's Impressive 21% Dividend Increase

By Markets Fool.com

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Source: company website

Don't look now, but Best Buy(NYSE: BBY) is making big moves. The electronics retailing giant just passed along a massive increase to its capital return program.

This is an astonishing development for a company that, just a few years ago, was left for dead by analysts and investors. Investors may recall Best Buy's dark days of 2011 and 2012, when the stock collapsed from $45 per share all the way to $11 per share, amid falling sales and the looming threat of the "showrooming" effect. Internet retailers such as Amazon.com and others, were supposedly going to steal Best Buy's customers.

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But as many market rumors have a way of doing, the showrooming effect never really materialized, certainly not to the extent the Best Buy bears had anticipated. The company responded quickly by aggressively cutting costs, and it has returned to sales growth. As a result, profits are back up, and Best Buy is back to its former glory.

Rumors of Best Buy's demise are greatly exaggerated
Turns out the showrooming theory wasn't all it was cracked up to be. Best Buy's sales and profits have recovered, and the company recently proved its strength in a big way. The company announced it will increase its regular quarterly dividend by 21%, from $0.19 per share to $0.23 per share. In addition, Best Buy will pay a special dividend of $0.51 per share, and will also buy back $1 billion of its own stock over the next three years.

Best Buy is able to do this because it's largely righted the wrongs that fueled its crash several years ago. At that time, U.S. comparable sales -- sales at stores open at least one year -- were falling, as was the company's operating profit margin. Management vowed to correct those problems, which it did. Domestic comparable sales grew 1% last year, and operating profit margin expanded by 80 basis points in 2014. The company achieved its goals through two key actions.

First, Best Buy aggressively cut costs. The company cut $480 million from its selling, general, and administrative cost structure last year. The second major benefit was the product refresh cycle in televisions and smartphones, which helped drive sales growth. Best Buy particularly benefited from online sales, which jumped 16% last year.

These initiatives helped Best Buy strengthen its balance sheet by raising cash. At the end of quarter, Best Buy held $3.9 billion in cash, equivalents and short-term investments, up from $2.6 billion at the same time last year. And, Best Buy's long-term debt to equity ratio is a very comfortable 49%.

Best Buy's U.S. comparable sales have returned to growth, margins are widening, and its balance sheet is strong. Because of this, the company is able to reward shareholders after a tumultuous past few years.

Cash flow supports increased capital returns
At first glance, investors may be wary of a company that increases its dividend, declares a special dividend, and announces a billion-dollar stock buyback, all at the same time. It's important to note that Best Buy is generating enough cash flow to support all these programs.

Best Buy generated $1.3 billion of free cash flow last year, up from $547 million the year prior. Best Buy's new regular dividend will cost approximately $323 million this year. Even with the huge increase, Best Buy's free cash flow payout ratio will still be a very healthy 25%. This leaves the $1 billion remaining to fund the company's buyback authorization, but since the share buyback program will be completed over the course of the next few years, there's plenty of cash flow to spare.. And, the special dividend will cost the company about $180 million, but this will be funded with the net after-tax proceeds from LCD-related legal settlements received in the last three fiscal years.

In short, Best Buy is back. The company righted the wrongs of the past few years. Comparable sales are up in the U.S., onlinesales are growing strongly, and Best Buy's balance sheet is in a much stronger position. Shareholders will now enjoy the fruits of these efforts with much higher cash returns.

The article The Secret To Best Buy's Impressive 21% Dividend Increase originally appeared on Fool.com.

Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.