Best Buy Takes the Long View, and Wall Street Glares

Best Buy (NYSE: BBY) CEO Hubert Joly says his company is now focused on growth -- which is a fairly impressive statement for a company that most pundits saw as doomed just a few years ago. In this Market Foolery podcast segment, host Mac Greer is joined by David Kretzmann and Aaron Bush of Supernova and Rule Breakers to consider the strategies that have brought the retailer back over the past five years, and its plans for the future -- which, admittedly, are likely to cause some near-term pain on the bottom line.

A full transcript follows the video.

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This video was recorded on Sept. 20, 2017.

Mac Greer: A rough day for Best Buy on Tuesday. The stock was down after the company outlined a new set of financial targets. David Kretzmann, we were talking before the show here -- really surprising that Best Buy over the last one, three, and five years has beaten the stock market. The stock has really had a nice comeback over the last five years. Then CEO, Hubert Joly, says that Best Buy is now focused on growth. Are you buying that, Best Buy as a growth story going forward?

David Kretzmann: I think they're in an interesting position here. I would expect them to continue beating the market over the next five years. What he mentioned in this presentation, looking back over the last few years, how has Best Buy stuck around? Because a lot of people, including just about everyone at the Fool, was basically writing them off. Like, they're selling commodity products, they're not going to be able to compete on price, Amazon (NASDAQ: AMZN) is a very convenient option. So Best Buy was essentially a showroom for Amazon. You go to the Best Buy store, figure out what you're going to order, and buy it on Amazon for $10 cheaper.

But he basically said, no, we were able to compete on price, and where we were able to differentiate ourselves with Amazon was an extra level of service, so really doubling down on that service aspect, saying, we're not going to try to sell these items at a higher margin compared to Amazon or other competitors. And so far, that's worked really well. They haven't really grown financially a whole lot over the last few years, but they also haven't slipped a whole lot, either. They've managed to stay relevant in a time when a lot of people had written them off.

And now, what they're doing, they're essentially taking that same strategy but really focusing on this in-home consultation strategy. They're offering the services. They'll have people go to your home for free and help give you this consultation if you're trying to install, maybe, a smart speaker or a TV or all these other smart-home devices. And I think that strategy makes sense as electronics become more complex, more expensive, more integrated with one another. They're really taking that same strategy, competing on price. They're not trying to charge people more for the same product that they can get on Amazon. They're adding that extra level of service. In the short term, that will be expensive for the company. So they're rolling that out nationally, so they will take a hit there, but Amazon is also testing a similar consultation strategy in a few cities. It's clearly, to me, the direction that they're going, I think that's a way that they can stay relevant, even though in the short term it will probably hurt a little bit.

Aaron Bush: Yeah, I think it's interesting, looking at Best Buy and the amazing performance of the stock. It makes me think of the tortoise and the hare a bit, and how everyone underestimated the tortoise, which is Best Buy, but here it is, it's kind of won the race. And now I feel like it has a little bit of an ego. So when it says it's going into growth mode, if you look at what they're forecasting for 2020, it isn't that fantastic. Revenue is still poised to maybe be up 10%-15% from now until then. EPS is higher. But that's more from buybacks and cost-cutting.

I still think they have a lot going for them. I think David nailed it on the head -- services is their differentiation, and that is increasingly going to be their source of competitive advantage. Making the Geek Squad a much bigger thing than it is, and going along with this home assistant, integrated home, smart-home trends, I think that's something that will be more important to them. That said, I tend to think that trend might be a little overrated. I still think that smart homes in general, they're not going to need a ton of help to install everything. With the Echo alone, you just plug that in.

Kretzmann: You're making that sound really simple, Aaron. Some of us aren't as technically adept. [laughs]

Greer: That's true.

Bush: Well, I just think the smart-home trend isn't going to arrive as quickly as people think it will. And they're also trying to get into elderly care along with that as well. And there are so many others trying to do the same. It just makes me question if Best Buy is going to be the one to do it. I really admire that they're trying to be a great service here for everyone, but I don't know, I'm still a little skeptical and paranoid, maybe.

Greer: OK, I will call you cautiously pessimistic.

Kretzmann: I think that's a diplomatic way to put it. A couple of things the CEO mentioned of why this strategy has worked -- because when you think about it, you're selling something that you can buy online. How are you going to do that and offer more service and make money doing it? He basically said that there's more margin at the high end, and people who are using those services are probably buying the more expensive products. And he was also saying that multichannel or omnichannel is a real asset, customers value having that complete experience, being able to have that hands-on time with a product and have that consultation.

And he also said it's not a zero-sum game. Best Buy is still the leader in consumer electronics market share in the U.S., and they've been growing market share along with Amazon. So he's basically saying, if anything, it's a competition between Amazon, Best Buy, and everyone else, not Amazon and Best Buy. And just looking at the financial picture of the company, it's a very stark contrast to Bed Bath & Beyond, which we talked about earlier. Strong balance sheet -- $2.3 billion in net cash; they're producing $1.3 billion in free cash flow annually. So they're in a very solid position as long as they don't jeopardize it and do some dumb buybacks and go into debt to buy back stock like Bed Bath & Beyond. And the valuation is still reasonable -- P/E ratio of 14 -- so they don't have to do a lot to beat the market from here, I don't think.

Aaron Bush owns shares of Amazon. David Kretzmann owns shares of Amazon. Mac Greer owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.