Best Buy Looking to Lift Profitability

Beyond these challenges, we've also explored the developing trend of increased mobile internet usage, and the potential threat this poses to Best Buy's key advantages.

Despite these obstacles, we believe Best Buy can benefit from better management of its inventory in 2011 and can also take steps to mitigate the growth headwind created by competitors.

What else is Best Buy doing? Best Buy's recent announcements indicate that the company is focusing efforts on more profitable stores, and closing those that are less profitable. The company is also looking to restructure its global operations to yield cost benefits.

Best Buy's Steps and Cost Benefits

Best Buy recently announced its plans regarding store expansion, with emphasis placed on growth areas like Best Buy Mobile stores in the U.S. and Five Star stores in China.

The Best Buy brand has struggled to gain traction in China and the company has decided to shift direction and close all its Best Buy brand stores in the region, as well as those in Turkey. Instead, it will push forward on operations of its Five Star stores, a local Chinese brand that Best Buy acquired some years ago.

The restructuring effort is expected to result in annual cost savings of about $60 million to $70 million beginning in 2013. However, the initiative will cost the company roughly $245 million over next couple of years.

How might this affect Best Buy's stock value?

Slight Margin Improvements Could Add Some Value, But Not Much

If we assume that costs and savings from the restructuring are incremental to our base forecasts, it implies that Best Buy may witness slightly compressed margins over the next couple of years and improvements thereafter.

How big could this be for the company? A back of the envelope calculation suggests that the cost savings could lift gross margins by barely 0.15%. So not a great deal of incremental value added. This calculation also assumes that all cost benefits are absorbed by the U.S. segment. Of course, in reality, this will be spread across all divisions, but the magnitude of the impact can be gauged by making this assumption to simplify calculations.

When comparing Best Buy's revenues ($50+ billion) to expected cost savings ($60 million to $70 million), one can understand why the upside benefit to overall company value might be limited.

Drag the trend line in the interactive chart above to see the affect of various U.S. store gross profit margin scenarios on Best Buy's stock value.