-- In our view, U.S. consumer electronics and services retailer Best Buy
Inc.'s weak operating and financial performance trends will continue due to
fierce competition and continued margin pressure.
-- We believe that it will be very difficult for the company to improve
its gross margin over the next year, given the industry dynamics and the new
management team's plans to turn around operations.
-- We are lowering our corporate credit and senior unsecured debt ratings
on the company to 'BB' from 'BB+'. In addition, the ratings are removed from
CreditWatch, where they were placed with negative implications on April 4,
-- The negative outlook reflects our view that if there is further
deterioration in operating performance, margins, and credit metrics, we would
consider lowering the rating.
On Nov. 21, 2012, Standard & Poor's Ratings Services lowered its corporate
credit and senior unsecured debt ratings on Richfield, Minn.-based Best Buy
Inc. to 'BB' from 'BB+.' The ratings are removed from CreditWatch, where they
were originally placed with negative implications on April 4, 2012. The
outlook is negative.
The recovery rating on the senior unsecured debt remains '3', indicating our
expectations for meaningful (50% to 70%) recovery in the event of a payment
The downgrade of Best Buy reflects our view that it will be very difficult for
the company to improve its gross margin in the fourth quarter of the year
given the highly promotional nature of year-end holiday retailing in the
wireless and consumer electronic categories. It is our belief that all
segments of the company's business will remain under margin pressure for 2012
and into 2013. In addition, we believe that the new management team still
needs to fully formulate its strategy for improving the continued decline in
same-store sales and margins. Given the highly seasonal nature of the
company's operations, skewed heavily to the fourth quarter, we may not begin
to see any tangible results until the second half of fiscal 2013 or beyond.
The ratings on Best Buy Co. reflect Standard & Poor's assessment that the
company's business risk profile is "weak" and its financial risk profile is
In our view, the company's "weak" business risk profile factors in the
inherent risks of the consumer electronics business, which is cyclical and
dependent on new products for propelling sales growth. It also incorporates
our view of the extremely competitive environment Best Buy faces from
internet-based retail formats, discounters, warehouse clubs, other big-box
retailers, and smaller regional consumer electronic chains, in many of its
product categories. We believe these factors and the commoditization of many
products will continue to limit pricing flexibility. In addition, margins will
continue to be constrained as the company looks to match competitors' pricing.
While the new management team has outlined the key problems the company faces
and acknowledges that many are self-inflicted, it will take some time for the
CEO and senior management team to full formulate its turnaround strategy and
execute it. In our view, we will not begin to see any tangible results until
the second half of fiscal 2013 at the earliest. Given that the strategy, cost
savings, and spending are all unknown at this time as well as its possible
success, we are therefore viewing the new management team and governance as
"fair." While these endeavors will be challenging, given the fierce
competition and commoditization of certain products, we believe that the
company's success depends on how quickly it can change its strategy to reflect
the shifts in the industry.
We assess Best Buy's financial risk profile as "significant," reflecting the
substantial seasonality in the company's operating performance, which is
heavily skewed to the fourth quarter; its adequate liquidity position; thin
margins; and weaker cash flow generation and credit protection measures. For
the 12 months ended Nov. 3, 2012, margins declined to 7.1% from 7.6% in the
previous quarter. We forecast that credit metrics will weaken further for
fiscal 2012, because we expect further gross margin pressure in the fourth
quarter. We estimate adjusted total debt to EBITDA of about 2.8x, EBITDA
interest coverage of about 4.9x, and funds from operations to total debt of
about 33%. This is based on our following assumptions:
-- Revenues and same store sales decline in the low-to-mid single digits.
-- Gross margin contracts by 100 basis points (bps) this year and next
-- Capital expenditures of about $750 million in 2012 and $800 million in
-- Dividends of about $230 million in both 2012 and 2013.
-- No further share repurchases until operating performance stabilizes.
We believe Best Buy's liquidity is "adequate" to meet its needs over the next
12 months. Furthermore, we estimate that there should be no significant
shortfalls in liquidity in the next two years, given that the company has
manageable debt maturities. Our view of the company's liquidity profile
incorporates the following expectations:
-- We expect that liquidity sources (including cash, cash flow from
operations, and availability under its revolving credit facilities) will
exceed uses by 1.2x or more.
-- We expect that liquidity sources will continue to exceed uses, even if
EBITDA were to decline by 15%, and that debt will remain more than 15% below
any covenant limits.
-- We believe that the company has the ability to absorb high-impact,
low-probability events, with limited need for refinancing. In our view, if
needed, liquidity could be supplemented by Best Buy lowering its capital
-- In our assessment, we believe that Best Buy has sound relationships
with banks and generally prudent risk management.
The company had cash and cash equivalents of approximately $309 million as of
Nov. 3, 2012, and full availability under its $1.0 billion 364-day senior
unsecured revolving credit facility, maturing August 2012 and a $1.5 billion
senior unsecured revolving credit facility, maturing Oct. 7, 2016. We expect
liquidity sources to largely fund seasonal working capital needs (which
typically peak in the third quarter), capital expenditures, dividends, and
2013 debt maturity.
We rate the company's unsecured debt 'BB' (the same as the corporate credit
rating) with a recovery rating of '3', indicating our expectation of
meaningful (50% to 70%) recovery for note holders in the event of a default.
Our negative rating outlook reflects our expectation that Best Buy's operating
trends will remain at their new lower level over the next year. We believe
that the same-store sales trend and revenue growth will be flat to negative
(in the low single digits) for the remainder of 2012 and into fiscal 2013,
given the weak industry dynamics in consumer electronics and the company's
recent performance. Also, we are estimating that margins will continue to be
under significant pressure.
We would consider a downgrade if gross margin contracts by more than 100 bps
and revenues decline in mid- to high-single-digits, resulting in debt leverage
trending to about 3.5x or more. In addition, we could lower the rating if the
company's cash flow generation continues to decline resulting in liquidity
concerns or we believe that the new management team's strategy for the company
does not begin to improve its operating performance. Also, we could lower the
rating multi-notches should the company receive and accept a leveraged buyout
Although unlikely in the near term, we would consider a stable outlook if
business conditions improve, such that Best Buy consistently posts positive
same-store sales and revenue growth and credit metrics strengthen. We estimate
that if gross margins improved by more than 150 bps and revenues rose in the
low- to mid-single digits, credit metrics would strengthen, with debt leverage
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrials
Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Temporary contact numbers: Jayne M. Ross (973-735-3761; Chuck Pinson-Rose
Downgraded; Recovery Rating Unchanged; Outlook Action
Best Buy Co. Inc.
Corporate Credit Rating BB/Negative/-- BB+/Watch Neg/--
Senior Unsecured BB BB+/Watch Neg
Recovery Rating 3 3