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Best Buy Co., Inc. (BBY), Staples, Inc. (SPLS): Retail Turnarounds Can Be Good Speculative Plays

Turning around a bad retail situation is a difficult task. The odds are very much against a broken store operator regaining its former glory, and a single management misstep could initiate a crisis that ends up in bankruptcy. On the other hand, shareholders can benefit greatly if a turnaround is successful. Even a stabilization of an under-performing retailer’s operations can provide good returns.

Best Buy Co., Inc.

Cash: An excellent indicator of turnaround success

It usually takes substantial time to produce a successful turnaround. Having a sufficient amount of cash on hand is the best means for ensuring the company can achieve its revamp. However, as cash levels decline the chance of insolvency increases.

When funds become tight, retailers can go bankrupt due to vendor credit problems. Retailers usually receive goods from vendors on credit. This credit is offered on the belief that they will be reimbursed once the items are sold. When vendors fear they might not be repaid, payment is demanded up front.

This change in terms is usually fatal to a weakened retailer. They typically rely on a single major selling season to generate the bulk of their profits. Prior to that season, retailers don’t usually expect to have the amount of cash needed to purchase the required inventory. If the retailer doesn’t have the cash to acquire enough items to fill the shelves, they usually have to file for bankruptcy just to keep the doors open.

A useful indicator of a company’s cash resource is the amount of cash at year-end (which can be found on the firm’s balance sheet) relative to its additions to property & equipment (which can be found in the cash flow statement). A company is at increasing risk as this ratio dips near 1.0 times.

Here are three interesting retail turnarounds:

Best Buy Co., Inc. (NYSE:BBY)

Best Buy Co., Inc. (NYSE:BBY), the consumer electronics retailer, is in the middle of a well-publicized turnaround. Its shares have ranged from a high of $24 to a low of $11 over the past year.

In its most recent quarter, the company had a weak 0.9% U.S. comparable-store sales increase, with a decline in gross profit margin. Best Buy Co., Inc. (NYSE:BBY) initiated a restructuring in response to its meager sales growth and profitability decline. The company’s “Renew Blue” plan aims to increase online sales, optimize efficiencies, and cut costs.

Best Buy Co., Inc. (NYSE:BBY) looks to have sufficient liquidity for the next year with a cash-to-additions in property & equipment ratio of 2.4x based on cash of $1.8 billion and expenditures of $742 million.

The company’s fair business value, based on expected cash earnings times a market capitalization multiplier, seems to fall in a range of $27 to $31 per share. This is based on $49.6 billion in revenue and about $1.1 billion in cash earnings for the last year, with those earnings discounted 5% and using a conservative 9x-to-10x multiplier, versus the standard retail 12x-to-14x multiplier.

Staples, Inc. (NASDAQ:SPLS)

Staples, Inc. (NASDAQ:SPLS) is the world’s largest office products company. Its shares have a 52-week high of $16 and a low of $10.

This company is also facing a tough operating environment. Sales for the latest quarter were $3.3 billion, a decrease of 4%, when excluding an extra week of sales. Comparable-store sales, which exclude Internet sales, decreased 5%.

In response, the company is planning reductions across the board in its square footage in North American Stores, global headcount and high-interest bearing debt to help reduce operating costs.

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