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Conservative balance sheet underpins positive view on credit

admin | June 12, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

BBY has historically maintained a very conservative balance sheet, underscored by a net cash position and strong credit metrics relative to other retail peers. Currently, BBY 4.45% 10/1/28 bonds are trading over 20 bp (g-spread) behind similar maturity issues from both Autozone and O’Reilly Automotive, providing investors an opportunity for attractive yield pick up.

BBY ended the most recent quarter with net cash of $1.4 billion (excluding leases). This compares very favorably to both Autozone Inc. (AZO -Baa1/BBB/BBB) and O’Reilly Automotive Inc. (ORLY – Baa1/BBB), which are both in net debt positions of $2.4 billion and $4.2 billion, respectively. BBY’s debt/EBITDA (ex-leases) is currently less than a turn at 0.7x, comparing to 1.1x at AZO and 1.8x at ORLY. On a lease adjusted basis, BBY’s estimated leverage is closer to 1.5x versus 2.6x at both AZO and ORLY.

Exhibit 1. BBB/BBB+ Retail Space – 7-10 year Curve

Source: Bloomberg TRACE; Amherst Pierpont Securities

Fiscal 1Q Results

While BBY’s Enterprise SSS were down 5.3% in fiscal 1Q due the pandemic, we note that it came in much better than street estimates looking for SSS to be down 10.8%. BBY saw a dramatic pick up in domestic online SSS for the quarter, with growth of 155%. Management noted that they were able to retain 81% of sales, despite a single store being open for customer traffic for half of the quarter. BBY moved all stores to a curbside only model on 3/22/20 while halting in-home installation, repair and consultation services. While BBY’s decline in SSS was worse that AZO and ORLY, which posted SSS declines of -1% and -1.9%, respectively, we note that both AZO and ORLY were deemed “essential” and stores remained open (although had reduced operating hours). Furthermore, BBY’s quarter ended 5/2/20, capturing 7+ weeks of stay at home orders in most states. ORLY’s quarter ended roughly a month earlier than BBY, with management noting that SSS for the four week period ending the second week in April down 13%.

Exhibit 2. BBY Cash vs. Debt

Source: BBY Company Report; Amherst Pierpont Securities

As stores reopened, BBY retained 95% of revenues in the first two weeks of May. Despite the dip in sales, gross margin remained flat to the year-ago period at 23%. As of 5/21/20, BBY is back in homes providing higher margin services to 80% of US zip codes, which bodes well for recouping some of the lost top line while improving margins. Additionally, BBY is set to re-open more than 800 locations on 6/15/20 (~65%+ of its store base). The company will continue to offer curbside pick-up and in-store consultations for customers that prefer to shop that way.

Further Enhancing Liquidity

Despite having already strong liquidity as the company remains FCF positive ($2.7 billion of free cash flow generated on a LTM basis) in addition to its large cash position, BBY took additional steps in the quarter to improve liquidity. While the company continues to pay a dividend, management has temporarily halted share repurchases. The share repurchase pause (depending on how long it lasts) could keep roughly $1 billion from going out the door on an annual basis. Additionally, BBY drew down its full $1.25 billion revolver on 3/19/20, but did not tap the debt market like most of its peers. The company also cut its full year capex spend from $800-$900 million to $650-$750 million, noting it will continue to invest in high value strategic areas but will be deferring spend on areas such as store remodels.

The Right Strategy

Despite the consumer electronics business being highly promotional and competition from the likes of Amazon (AMZN A3 (p)/AA-/A+ (p)), Walmart (WMT Aa2/AA/AA) and Target Corp. (TGT – A2/A/A-), BBY has seemed to find the right strategy to resonate with customers. BBY has become a trusted retailer for consumer electronics vendors including Apple, Amazon, Google, Microsoft, Samsung and Sony. BBY’s vision to properly utilize square footage to showcase products that consumers typically like to test prior to purchase coupled with investments in its staff and a strong and growing services business has helped differentiate BBY from its competition. BBY is also forging a path in healthcare services for aging seniors, with its acquisitions of GreatCall and Critical Signal Technologies (CST). These devices and services not only help seniors live longer in their homes, but also help to reduce health care costs for their customers. Furthermore, they are a great complement to BBY’s Geek Squad and In-Home Advisors services as more customers are demanding “smarter” homes.

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