It doesn’t seem like all that long ago that Best Buy’s stock and bonds were tanking and the investment community had the company pegged as doomed. Since the beginning of 2013, however, things have changed. The stock, trading under $12 per share at the end of 2012, recently topped $30. The bonds have also seen notable improvement since the beginning of the year. As the two charts below illustrate, yields on the 2016 and 2021 maturing Best Buy notes have declined significantly in recent months.
Given the improved investor sentiment toward Best Buy, the timing was nearly perfect when the company recently issued $500 million of March 1, 2018 maturing senior unsecured notes (CUSIP 086516AM3). The new notes, which first settled just one week ago, have a 5.00% coupon, a make whole call at the Treasury Rate plus 50 basis points, and will pay interest semiannually. There is also a conditional put for a change of control. In the event of a “Change of Control Triggering Event,” Best Buy will be required to repurchase notes at 101. A “Change of Control Triggering Event” means the occurrence of both a change of control and a rating event. Specific details can be found in the Prospectus Supplement dated July 11, 2013.
With the new 2018 maturing notes currently offered for just under par, a 5% yield for five years is something that may entice many investors. As an owner of Best Buy’s 2021 maturing notes (CUSIP 086516AL5), I find Best Buy’s bonds to be appropriate for my portfolio. But even so, it is important to recognize that risks do exist. The aforementioned Prospectus Supplement outlines several of those risks, including, but not limited to, the following:
1. Under the indenture governing the notes, Best Buy is not restricted from incurring additional unsecured debt.
2. Best Buy’s credit agreements contain restrictions that limit the company’s “flexibility” in operating the business.
3. The notes are structurally subordinated to the debt of Best Buy’s subsidiaries.
Moreover, there is, of course, the risk that business materially worsens. But one thing to keep in mind is that at the end of the day, individual bonds prove to be AAAs or Ds. In other words, they fulfill the terms of the notes or there is a default. Best Buy could experience a deteriorating business environment that wreaks havoc on the stock and still make good on its debt obligations. Your job, as an individual bond investor intending to hold notes to maturity, is to figure out whether the company will make good on its obligations between now and when the notes mature. I think Best Buy is still well positioned to do that, and I would like to highlight some of the company’s positives.
1. As Moody’s noted in its July 12, 2013 rating action for the 2018 notes, “Best Buy’s Baa2 long-term rating continues to reflect the company’s position as the largest dedicated consumer electronics retailer, its highly diversified and innovative product line, its credit metrics, and very good liquidity.”
2. Also from the July 12, 2013 Moody’s rating action: “Ratings support is also provided by the company’s demonstrated ability and willingness to reduce share repurchase activity in order to maintain its Baa2 credit profile.” As a bondholder, I like to see that a company is willing to reduce share buybacks to protect a rating. It also makes me more confident that the company would be willing to reduce the dividend in order to protect the rating.
3. Any success by states to collect sales taxes from online purchases is a positive for Best Buy. Although consumers are still required under current laws to pay sales taxes on purchases made online, most people do not. And because they do not pay the required taxes, it helps widen the gap between the final prices that some online retailers collect versus what a consumer will pay when making a purchase at Best Buy.
4. I have heard people refer to Best Buy as Amazon.com’s showroom. While Amazon.com is certainly a formidable presence in the online retail space, Best Buy also has a well-visited website and is working on growing its online/mobile presence. In Q1 FY 2014, Best Buy grew its domestic segment online sales by 16.3%. With the online sales channel being a fairly fragmented market, Best Buy’s opportunity to grow its online market share is large.
5. There is a price perception gap between Best Buy and Amazon.com. Best Buy’s price matching policy should help to narrow that gap over time. But until online sales taxes are collected by Amazon.com, it will be tough for Best Buy to bridge the price gap created by taxes on major purchases.
6. Best Buy is, as so many companies around the world are, focused on reducing costs and becoming more efficient in its operations. This includes negotiating rent reductions, closing some larger stores while focusing on expanding the number of its smaller Best Buy mobile stores, and eliminating approximately $175 million in SG&A during Q1 2014.
7. According to the November 13, 2012 analyst and investor day presentation, in 2012, Best Buy was estimated to have the top retail loyalty program at approximately 75 million members (40 million active members). Such a large and active loyal customer base is a positive thing and should help Best Buy remain competitive for the foreseeable future.
In today’s challenging interest rate environment, 5% yielding five-year notes from a major player in the consumer electronics space is worth considering. But please keep in mind that this article is for informational purposes. Only you can decide if taking the counterparty risk of investing in individual bonds is right for you.
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