MEMORANDUM
Best Buy Co., Inc Analysis
Introduction
Best Buy is an accredited consumer electronics retailer. The company has a strong presence all over the world. That makes it a very interesting consideration for investment since the demand for consumer electronics will not slow down any time soon. Investors will always take a keen interest in a company’s nature of business, major costs, management style as well as financial performance before deciding on the company to invest in. This memo attempts a detailed analysis and description of the Best Buy’s activities, financial performance and future outlook, (Business, 4)
Revenue Generation
Best Buy Inc generates revenue through the retail of consumer electronics. The company is the largest multi-channel retailer in the world with presence in China, Mexico, Canada and the United States of America. Some of the products retailed by Best Buy are mobile phones, televisions, computers, tablets, washing machines and home theatres. In addition, the company offers technical assistance services as part of the business portfolio. These services include installation, repair or replacement of the products through the Geek Squad brand, (Management’s Discussion and Analysis of Financial Condition and Results of Operations, 24).
Best Buy runs an operation mix divided into two categories; domestic and international. The company has both online retail services as well as physical stores. E-commerce has enabled the company to create strong internet presence to compete out similar stores and retailers. The Geek Quad is composed of 20,000 employees ready to offer technical assistance around the clock. Some of the most known brands from Best Buy include Five Star, Future Shop, Best Buy Mobile and Best Buy, (Management’s Discussion and Analysis of Financial Condition and Results of Operations, 24).
The above description shows Best Buy as a perfectly positioned retailer. It also affirms the company’s strategy to dominate the multi-channel electronics retail market by leveraging on technology to improve people lives.
Accounting for revenues
Financial statements are prepared in compliance with Generally Accepted Accounting Principles (GAAP) and audited by Deloitte & Touche, a reputable auditing firm. The objective for the audit is to create a fair opinion on the picture presented in the financial reports concerning whether the reports represent the actual picture of the company. The audit firm operates under the standards put in place by the Public Company Accounting Oversight Board, a body that ensures that all audit firms stick to laid principles.
Revenue recognition follows the rules put in place in the IFRS (International Financial reporting standards). That means that there is actual transfer of products or services to the clients.
Best Buy Major Costs
The major costs for Best Buy are; cost of goods sold (COGS) and the sales, general and administrative costs (SG&A). COGS is the biggest single expenditure in the income statement as it eats out more than 75% of the total revenue. COGS is the cumulative expenses incurred from the sourcing of products from manufacturers, carriage inwards and restructuring costs, mainly inventory write downs. Restructuring costs, for Best Buy case, are expenses incurred in repositioning the company to cut operation costs and increase profit margins, (Year to year comparison, 33)
Sales, General and Administrative costs component of the income statement is the major expense. For the last five years, this component has averaged at 20% of the total revenues and 82.5% of the gross profit. It is important to note that the management has put in place a cost reduction strategy that has seen the sales, general and administrative cost go down to 19.7% of the total revenues, (Selected Financial Data, 23).
The Sales, General and Administrative component of the income statement represents all costs incurred in the day-to-day running of the business. Examples of expenses falling in this category include management expenses, salaries, rent, and staff training costs just to mention a few. Concerning sales, administration and general cost component as a percentage of the gross profit, the management’s ability to control the size of the percentage is the key determinant of profitability of the company, (Selected Financial Data, 23).
Cost of Goods Sold and Accounting for Sales, General and Administrative costs (Major Costs)
Annual income statements present the two categories of major costs as single components of the income statement, (Selected Financial Data, 24). For the COGS, valuation is done on the first in first out (FIFO) basis or using the average cost method, whichever is lower. Transport and storage costs are expensed as incurred and included in the COGS. Hence, the value of COGS includes expenses for unsold inventories. Other costs incurred in the COGS are vendor allowances, costs of services provided like payroll and benefits to services employees as well as cost of replacement, (Costs of Goods sold, Selling, General and Administration section, 69)
Disclosure of SG&A as a single component in the income statement leaves potential investors guessing on the specific cost component and the actual value, (Selected Financial Data, 24). A list of the costs included in the SG&A does not give a clear breakdown of the costs. However, the company provides a list of the components making up the SG&A. The main costs, according to the list, include staff and benefit costs, occupancy and maintenance as well as advertising costs. The costs are accounted on accrual basis using the GAAP, Costs of Goods sold, Selling, General and Administration section, 69)
Accounting for Assets Used in Revenue Generation
The main assets used in revenue recognition by Best Buy are merchandise inventories, cash and cash equivalents under the current assets category. On the other hand, Property and Equipment mainly comprises of land and buildings, leasehold improvements as well as fixtures and equipment. Of the mentioned costs, merchandise inventories form the most important revenue generation asset as inventory represents the actual products retailed by the company, (Selected Financial Data, 23).
The assets are included in the consolidated balance sheet. For example, the inventory for the previous year forms the opening inventory for the current year. Hence, to calculate average inventory, or any other asset, you take previous year inventory (2013 in Best Buy case); add the current period inventory (February 2014) then divide by two. The assets value is used to calculate efficiency of the company in regards to utilization of assets to generate revenue, (Selected Financial Data, 23).
Depreciation on fixed assets is calculated on a straight-line basis. The depreciation expense is included in the SG& A expenses. Treatment of depreciation of assets is necessary for fair presentation of the assets value in the business.
Debt Structure of Best Buy
Debt structure refers to the mix debt instruments taken by the business. Best Buy maintains a very low level of debt financing thus reducing the interest expense charged by debt holders. From the February 2014 financial reports, Best Buy has taken notes that will mature in different periods from 2016.
Apart from the notes, Best Buy has a debt financing that totals to 1,635M USD. Debt forms a 26.5% of the total capital structure. The debt is mainly comprised of floating bonds that traded in the market, (Morning Star, Ownership)
Financial Flexibility for Best Buy
Best Buy has a very healthy capital mix. Capital structure is a representation of the mix between debt and equity in a company. Debt refers to fixed income debt facilities with specific maturity periods. A financially flexible company has its debts covered by assets. The debt should also form a relatively smaller portion of the total capital of the company. The debt to equity ratio is used to measure how much a company is leveraged. The ratio for Best Buy is 40:60. That means that 40% of the company’s capital is a debt, (Growth, Profitability and Financial ratios for Best Buy, Morningstar 2014)
For Best Buy, the debt ratio is 68%. Debt ratio is calculated as total liability divided by the total assets. The measure reveals how the company is balancing off its liabilities and assets. On the other hand, quick ratio measure how the current liabilities are covered by current assets. For Best Buy, the quick ration is 1.41, a revelation on the management commitment to keep operations efficient and liabilities covered in the short term, (Growth, Profitability and Financial ratios for Best Buy, Morningstar 2014)
Holding of cash and cash equivalents enables a company to stay on its feet in the event of economic downturns. In the balance sheet, cash holdings represent 20% of the total assets, second to the value of inventory at 33%. The cash held by the company has increased steadily as a percentage of the total assets over the last four years. Therefore, the company has a more stable financial build up to take advantage of opportunities in the industry, (Growth, Profitability and Financial ratios for Best Buy, Morningstar 2014).
Ownership Structure of the Company
Best Buy Co., Inc is a limited liability company. That means that the company is owned through a mix of debt and equity at a ratio of 28:72. The liability arising from business operations is limited to the shareholder capital invested in the business. In that regard, therefore, the shareholder or investor will not incur direct losses from court rulings against the company. S/he will not offer personal resources in the process of liquidation. The shares for Best Buy are floating in the stock exchange market, meaning that the investor can terminate his share ownership by selling his shares at market prices.
Best Buy Major Estimates
Estimates form a major part of financial statements. Some companies have projected results for up to three years reported in the financial statements while others, like Best Buy, prefer to go silent on the long-term outlook. However, other estimates appear in the subsections of the financial statements. For example, for Best Buy, earnings will dip due to an increased gift card breakage and a change of the customer loyalty program. The net earnings reduction in the fiscal year 2014 is 37 million dollars, by estimation, (Critical accounting Estimates, 51)
Estimates in the financial statements usually give investors an idea on the management expectations driven by current demand patterns. Investors and analysts take a keen interest in estimations with a view to establish future earnings and share value growth. The estimates are used to determine industry and sector challenges by comparing ambitions for players in the same industry (Investopedia, Ratio Analysis).
Importance of faithful representation of the financial statements
Investors will look at the financial statements to determine the future direction of a company. A company with a very healthy balance sheet and income statement will surely have a better outlook. That will encourage potential investors to buy shares and hold for either future dividends or gains on share value. If the statements are unfaithfully represented, investors will run a risk of below expectation returns and loss on share values.
For the government, a fair representation of the financial statements enables the determination of tax liability to be paid by the company. A company with an unfaithful representation of financial statement is at the risk of penalization by the tax collector or complete suspension from operations. The management is liable to such risks.
Recommendation on Best Buy Shares
The company has a very positive outlook. The Renew Blue transformation strategy is into its second year and the management looks forward to better than expected returns. Best Buy has repositioned its business by investing in the online part of the business to match up industry competitors like Alibaba.com and Conn’s Inc.
The economy is back on track and the demand for consumer electronics will rise. That will be occasioned by compensation consumer behavior as they try to catch up on technology as they have higher disposable incomes. A recent economic outlook by the Economist showed increased employment for new graduates, a group that is usually interested in electronics and mobile handsets as they move in to their own apartments.
All these factors favor a decision to buy Best Buy shares. My recommendation, therefore, is BUY and HOLD.
Recommendation on Best Buy 10-year Bond
I would recommend the purchase of Best Buy treasury bonds. The company has not beaten the Standard Poor 500 companies (S&P 500) for the last five years and it has performed below industry average. Hence, a ten-year bond would be very rewarding, as investors would demand a very high interest rate given the past five-year financial performance.
Conclusion
Best Buy Co. Inc. is a home appliance partner with a strong presence in the multi-channel electronics sector. A strong management and healthy financial status makes it a very interesting venture for an investor to put his money. Considering all the factors that make the company an interesting venture, an investor can buy the stock with a definite hope that growth will occur both in capital gains and in dividend payouts. The recommendation to buy hinges on the simple concept that the outlook is for Best Buy is very positive hence it promises returns to investors.
References
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