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Best Buy's balance sheet is not strong [ClearOnMoney]
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Best Buy's balance sheet is not strong

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Commentary

Best Buy's balance sheet is not strong

28 Sep 2012 by Jim Fickett.

Best Buy's debt is on the boundary between junk and investment grade, and its debt/equity ratio is worse than the industry average. This will limit its flexibility in changing overall strategic direction.

In August S&P lowered Best Buy's credit rating to junk, on the threat of a leveraged buyout. But even before that, the S&P rating was the lowest of the investment grades. From the Wall Street Journal:

Standard & Poor's Ratings Services and Fitch Ratings downgraded Best Buy Co.'s (BBY) ratings to junk territory, noting an offer by the electronics retailer's founder and biggest shareholder would add substantial amounts of debt.

The offer also prompted Fitch to place Best Buy's ratings on watch for further possible downgrade and Moody's Investors Service to change its outlook on the company to developing from stable.

… amid Monday's offer by Richard Schulze, founder and former chairman of the big-box electronics retailer, to buy the remaining shares of the company in a deal that values it at as much as $8.8 billion.

S&P lowered Best Buy to double-B-plus, one level into junk territory, from triple-B-minus. S&P said the ratings remain on CreditWatch with negative implications, reflecting the potential for a further multinotch downgrade depending on how much debt is included in any completed buyout, as well as concerns about how Best Buy adapts to shifts in the consumer retail sector and any possible restructuring plans.

S&P had placed Best Buy's ratings–which were on the brink of junk–on watch for a possible downgrade in April after a major restructuring plan highlighted challenges facing the retailer. The move came as Best Buy had booked $1.6 billion of restructuring costs and other charges for its fiscal fourth-quarter amid plans to close 50 of its big box stores in the current fiscal year and open 100 mobile standalone stores as part of its cost-cutting plans.

Meanwhile, Fitch lowered its ratings to double-B-plus, in line with S&P's new rating, from triple-B-minus. The firm said Best Buy's weakening same-store sales, continued margin pressure and heightened event risk is no longer consistent with an investment-grade rating.

Moody's affirmed its rating at Baa2, two notches into investment grade, and said its revised outlook reflects the uncertainty regarding the potential impact of Mr. Schulze's bid on the company's capital structure.

Morningstar notes that while debt/equity, at 0.63 is higher than the industry average of 0.25, and EBITDA/interest, at 6.14, also compares unfavorably with the industry average of 13.91, cashflow from operations / total debt, at 1.48 is better than the industry average of 1.05. With EBITDA/interest at 6.14 and strong cashflow, Best Buy is certainly nowhere near default.

The main take away from the somewhat weak balance sheet numbers is that Best Buy does not have as much flexibility as one might desire in changing strategic direction. For example, the firm has closed a number of its big-box stores and expanded in smaller, mobile-devices-only stores instead. Such moves, if carried out widely, require a great deal of capital. Fortunately, one of the key changes required at the company, namely improving the customer experience, probably requires mainly the replacement of a few store managers and a change in the employee incentive structure, which should not be too expensive.

Previously on Best Buy