NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed its long-term Issuer Default Rating (IDR) on Best Buy Co., Inc. (Best Buy) at 'BB-'. The Rating Outlook has been revised to Stable from Negative.
Key Rating Drivers
The ratings reflect Fitch's expectation that top line and EBITDA will remain under pressure through 2013. While Best Buy has dominant market shares in many categories, Fitch estimates that the majority of product categories in which Best Buy operates are in a secular decline, and the only bright spots are mobile, tablets, and appliances. However, Fitch has increasing conviction that management's investments in sharper pricing funded by cutting excess costs and changing the revenue mix towards these higher growth and higher margined products could stem losses both in the top line and EBITDA over the next 24 to 36 months.
Managing the Business Model Risk: Best Buy has been struggling to defend its share against the onslaught of competitive pressure from e-tailers and discounters. Moreover, the online channel has grown faster, and taken share away from, the bricks and mortar channel. As such, Best Buy has seen negative comparable store sales (comps) for the past seven of nine quarters. EBITDA declined 20% in 2012 and 38% in the first quarter of 2013, excluding discontinued operations related to Best Buy Europe. Second quarter results point towards some stabilization with domestic comps down slightly at 0.4% (the domestic business accounts for 84% of sales and close to 90% of EBITDA). Online domestic comps increased 10.5% and Fitch estimates store level comps at around negative 1%. Overall EBITDA was essentially flat in the second quarter as gross profit decline (due to greater investment in price competitiveness, higher inventory shrinkage, and increased product warranty-related costs) was offset by lower SG&A costs.
While Best Buy has dominant market shares in many categories, Fitch estimates that the majority of product categories in which Best Buy operates are in a secular decline and presents a significant headwind to the overall mix of the business. Fitch estimates that these categories - mainly computing ex-tablets, entertainment and consumer electronics - will decline in the high single digits over the next three years, given the lack of new product introductions, price deflation, and shift towards digital products.
The only growth areas are mobile, tablets, and appliances. Fitch expects these three categories in aggregate carry higher gross margins than the company average and expects these businesses in total to grow in the low double digits over the next three years.
Management is making concerted efforts to reduce square footage dedicated to negative growth and very low margin areas such as entertainment (physical media) and to shift mix towards the higher growth and more profitable categories. In addition, these initiatives are being supported by dedicating more space to strategic partners such as Samsung and Microsoft.
Based on the current mix of the business and assuming no active management of the product offering, Fitch expects that sales will continue to decline in the low single digit range and gross margins will gravitate towards the 22%-23% range over the next 24-36 months. However, changing the product mix towards higher growth categories could stabilize the business over the intermediate term.
Leverage Expected to Increase: Fitch expects EBITDA to be around $2 billion in 2013, versus $2.4 billion in 2012 and $3 billion in 2011 (excluding Best Buy Europe). As a result, adjusted debt/EBITDAR is expected to increase to 3.0x in 2013 versus 2.7x in 2012 and 2.9x for the LTM period. Fitch expects leverage could creep up to the mid-3.0x range over the next 24 months on modest top line decline, some gross margin decline due to continued price investments offset by some cost reduction. However, should sales stabilize or turn slightly positive, EBITDA could return to 2012 level of $2.4 billion.
Strong Liquidity Position: Best Buy had $1.9 billion of cash and unused domestic revolver capacity of over $2.0 billion at Aug. 3, 2013. This reflects the company's new $500 million 364-day domestic senior unsecured RCF that replaced the previous $1 billion facility due August 2013. The downsize in the facility was offset by approximately $650 million in cash proceeds from Best Buy's sale of its 50% interest in Best Buy Europe to Carphone Warehouse Group plc during second quarter 2013.
Best Buy has suspended its share repurchase program since first quarter 2012 to preserve liquidity. The company still pays regular dividend annualized at $220 million -$230 million.
Fitch expects free cash flow (FCF; after dividends) to be around $300 million in 2013 assuming a negative working capital swing of $350 million. The company can sustain FCF in this range assuming working capital swings are neutral in 2014 and 2015 based on Fitch's EBITDA expectations.
In July 2013, Best Buy issued $500 million of 5% notes due in August 2018 and used the net proceeds to repay the $500 million of 6.75% notes due July 15, 2013. The next maturity of unsecured notes is March 2016.
Negative Rating Action: A downgrade could be caused by the following factors, individually or collectively: worse-than-expected sales declines in the mid-single-digit range versus Fitch's low single-digit-range projections; significant gross margin declines, without any significant offset from cost savings, thereby putting further pressure on EBITDA; or adjusted leverage above the low-4x range.
Positive Rating Action: Fitch would need to see stabilization in comps trends and EBITDA on a sustainable basis to consider a positive rating action.
Fitch has affirmed its ratings on Best Buy as follows:
--Long-term IDR at 'BB-';
--Bank credit facilities at 'BB-';
--Senior unsecured at 'BB-'.
The Rating Outlook has been revised to Stable from Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Evaluating Corporate Governance' (Dec. 12, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Evaluating Corporate Governance