I Still Don't Believe in Best Buy (BBY)

At the beginning of 2014, Best Buy investors had high hopes that the electronics retailer was back on track after a couple of painful years. They soon learned that Best Buy had not quite fixed its problems when it reduced its Q4 earnings guidance in mid-January.

This triggered an immediate 35% drop in Best Buy's share price. The stock has been gradually regaining ground since then and is approaching the pre-sell-off level again.

BBY data by YCharts

Despite Best Buy's somewhat better results in recent quarters, Best Buy shares appear overvalued at current levels. The company's earnings multiple has been on the rise again, while its prospects for long-term earnings growth remain dim.

Strengthening earnings results

On the positive side, through the first three quarters of FY15, Best Buy increased its adjusted EPS by more than 30% year-over-year, from $0.83 to $1.09. Additionally, it achieved fairly strong domestic comparable-store sales growth of 3.2% last quarter. (The increase would have been 2.4%, excluding the accounting impact of selling smartphones on installment-billing plans.)

Best Buy's international results have been weaker. However, the company recently made substantial progress in addressing that issue by agreeing to sell its Chinese subsidiary, Five Star. This will allow the management team to devote its full attention to turning around Best Buy's North American operations.

But tailwinds are dissipating

On the other hand, it's important to recognize that Best Buy's earnings stabilization can be traced directly to its "Renew Blue" cost-cutting strategy. In November 2012, Best Buy CEO Hubert Joly introduced this plan to cut $725 million in costs in order to boost profitability.

In terms of the cost-cutting goals, Best Buy has outperformed. Best Buy raised its cost-cutting goal to $1 billion earlier this year. It has nearly hit that goal; as of the end of last quarter, Best Buy had reached a run-rate of $965 million in annual savings.

Best Buy has cut costs by almost $1 billion (Photo: The Motley Fool)

However, the ultimate goal of profit growth has remained elusive. In FY13 -- the year before Best Buy began implementing its cost-cutting campaign -- Best Buy generated adjusted EPS of $2.62. EPS then dropped to $2.07 in FY14. Analysts project that EPS will rise this year to $2.40 and increase again next year to $2.66.

Even with the full benefit of $1 billion in annual cost savings next year, analysts expect Best Buy to produce roughly the same earnings as it did before those cuts went into effect. That's a testament to the tough competitive environment Best Buy faces.

Going forward, the tough competitive environment will remain. Best Buy executives recently told investors that the current holiday season could be even more brutal than last year's. However, there will be fewer opportunities to offset this pressure with meaningful cost cuts, as Best Buy has already gone after the low-hanging fruit.

Where's the growth?

Today, Best Buy shares trade for more than 13 times forward earnings. While that's somewhat lower than the market average, it still implies that investors expect some long-term earnings growth.

Given the limited incremental cost-cutting opportunities, EPS growth would have to be driven primarily by organic revenue growth. (A resumption of share buybacks could also contribute.) Yet long-term sales trends in consumer electronics are not encouraging, and the growth of e-commerce represents another headwind.

In the short run, Best Buy could benefit somewhat from the downsizing of RadioShack and Sears. Looking further out, Best Buy's growth prospects probably aren't sufficient to support the stock's current valuation.

The article I Still Don't Believe in Best Buy (BBY) originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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