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Best Buy Co., Inc. (BBY) – The Turnaround Continues: Part II

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J.C. PenneyIn Part I of this article I looked at the first half of Best Buy Co., Inc. (NYSE:BBY)‘s turnaround strategy, dubbed “Renew Blue.” This included accelerating online growth, improving the customer experience with more competitive pricing and various initiatives, and optimizing square-footage with a store-within-a-store concept and dedicated clearance sections. The second half of the strategy involves three different ways in which Best Buy Co., Inc. (NYSE:BBY) is working to cut costs in an attempt to become a leaner, more nimble company.

Driving down the cost of goods sold

Joly believes that the company can reduce the cost of goods sold by $325 million, and to date has already delivered $30 million of those savings. The company has worked to optimize its inventory replenishment system, resulting in a reduction of loads and miles driven for its trucks. This process is only half complete, and the remaining work will be done in the second half of the year.

An area where big savings can be found is in reverse logistics, i.e. returns, replacements, and damaged goods. The company estimates that this area is responsible for about $400 million in losses annually, representing a big opportunity for cost savings. Dedicated clearance zones and the buy online, ship from store initiative should help reduce those losses, especially considering that clearance items at the store level can be bought online.

Optimizing the real estate portfolio

One of Best Buy Co., Inc. (NYSE:BBY)’s largest expenses is rent on its properties, and the company has been gradually working to realize savings in this area. During the first quarter rent was renegotiated for some stores and one large-format store was closed. In addition, Best Buy Co., Inc. (NYSE:BBY) is opening more small-format mobile stores even as large-format stores are being shuttered. Ten of these mobile stores were opened in the first quarter, and the company plans to open two more later this year.

SG&A cost reduction

Best Buy Co., Inc. (NYSE:BBY) believes that about $400 million in cost savings in Selling, General, & Administrative (SG&A) expenses can be achieved in the domestic market, and so far the company has found $295 million in savings, nearly 75% of the total in a very short amount of time. These costs cuts includes things like cutting 400 jobs at its headquarters in February, removing layers of management in an attempt to make the company more efficient. It’s likely that the remainder of the cost savings will be realized more gradually.

The financial picture

Because last year’s first quarter contained sales relating to the Super Bowl while this year’s results did not, comparing numbers directly is a bit dubious. It’s safe to say, however, that profits have declined. The exact amount is questionable, but price cuts and aggressive investments have certainly lowered profitability.

However, Best Buy was still plenty profitable during the quarter. Instead of looking at net income or free cash flow I like to look at owner earnings to gauge true profitability. Owner earnings for the quarter were roughly $210 million, or $0.61 per share. This is down sharply from last year, but it paints a much rosier picture than the non-GAAP EPS or the free cash flow would have you believe. Owner earnings in the last fiscal year, which I calculated here, came out to $4.14 per share. It’s likely that owner earnings will be lower this year, but even simply annualizing the first quarter results to $2.44 per share leaves the company trading at a little over ten times owner earnings. And this doesn’t include the effect of the much more profitable holiday season to come.

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