Barron's Streetwise - Turnaround Talk with Best Buy's Former CEO

Episode Date: May 7, 2021

How Hubert Joly brought the electronics chain back from the brink. Plus, UBS strategist Evan Brown on rising inflation. Learn more about your ad choices. Visit megaphone.fm/adchoices

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I'm sorry, all of the stores are profitable. Why would that be a good idea? So it was a people-centric turnaround, listening to the frontliners, building the right team. From a lever standpoint, grow revenue first. It's amazing what growth can do. Welcome to the Barron Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Hubert Jolie. He teaches business administration at Harvard Business School, but he's better known as the guy who turned around Best Buy and multiplied the value of its shares in the process. In a moment, we'll hear from Hubert about how to go up against Amazon and

survive, even thrive, and how investors can tell which struggling companies might make good turnaround candidates. Also, inflation. Should I be freaking out about it, or should I be poo-pooing the people who are freaking out? I've lost track. I'll ask a UBS strategist. Listening in for one last week before maternity leave is our audio producer, Metta. Hi, Metta. Hey, Jack.

I saw a picture of a onesie that some of our colleagues sent you. And on the front, it says Barron Streetwise with Jack Howe. And Metta, I've got to say, first, I've never seen my name on a onesie before. And second, I think this could be an important new revenue engine for the company. I mean, do you have plans to go to market with a Barron Streetwise onesie? And will you be tweeting a picture of the prototype at some point to generate some pre-market buzz? Yes and yes. Okay.

And do they make it in a men's XL? I'm asking for a friend. I'm really hoping so. We'll have to talk about pricing strategy later. Let's shift our attention now to a few quick observations about investment markets. Number one, the outlook for company earnings is good and getting better. Companies have trounced estimates for first quarter earnings and estimates for the second quarter have been rising at one of the fastest paces on record. The way things stand now, earnings for the full year are expected to come in 34% above last year's depressed level.

Okay, big walk, but that's also 15% above the record earnings that were recorded before the pandemic in 2019. Now, observation number two is that even considering the good news for earnings, U.S. stocks look expensive. The S&P 500 trades at nearly 23 times this year's earnings estimate. That's around 50% above its historical average. Of course, interest rates and bond yields are nearly as low as they've ever been, which makes stocks look good by comparison. And it helps explain why stock valuations are so high, which brings me to observation number three. There are scattered signs that inflation is picking up. Breaking news, our March read on Consumer Price Index. And believe mean, America's headline inflation measure,

called the Consumer Price Index, rose 2.6% over the year through March. That's higher than what we've seen, but it's not remarkably high, especially considering that if we ignore energy and food prices, so-called core inflation was only 1.6%. I think it does make some sense to set aside energy prices for the moment because a year ago we weren't driving at all, and now we're driving more. So it's understandable that fuel prices have picked up. Let's call that a one-off. A couple of weeks ago on this podcast, we talked about how lumber prices have soared because lumber yards got caught by surprise on demand from home builders and do-it-yourselfers, and sawmills can't keep up.

So that's another one-off lumber. But grain prices have jumped too, and steel prices, and you can only have so many one-offs before they don't look like one-offs anymore. I mean, one-off has one right in the name. It's not called a four-off. All these rising prices have largely been affecting goods producers, but they could soon flow through to consumers and the consumer price index. And that matters because a moment ago we said that one reason stock valuations are so high is that bond yields are so low. Well, bond yields can only stay this low if inflation stays low too. So if inflation picks up and if policymakers or the bond market responds,

or if stock investors merely think that policymakers and the bond market will respond soon, stocks could slide. I should point out that the inflation rate is widely expected to rise during the second quarter, but the increase is expected to be temporary. And that raises an interesting question. If investors do in fact see a jump in inflation in the months ahead, will they remain patient and calm and wait to see if it subsides later this year? Or will they panic? There's a lot at stake, and politics can muddy the waters. Pundits who lean to the right or to the left might be more or less lean to the right or to the left might be more or less likely to declare

that inflation is becoming a problem. And that's not helpful to investors who are trying to get an unbiased read on the facts. To get a fresh perspective, I checked in with Evan Brown. Hi, Evan. Jack, how are you? I just minutes ago got my second vaccine shot.

How long do I need to let go by before I can begin making excuses for sounding foggy or losing my train of thought? Unfortunately, I think it's 12 hours or so. Oh, no. Evan is the head of macro asset allocation strategy at UBS. Asset allocation, of course, refers to divvying up investment dollars among stocks, bonds, and other assets for optimal results. And macro means you make decisions based on economic cycles. So Evan is well-positioned to talk about where we are in the economic recovery and what to

do with our money. I asked, how nervous should I be about how well the stock market has done up till now? He says the outlook is still positive. When we look at valuations historically from just a pure multiple level, then yes, stocks look extraordinarily expensive. If we're looking at relative to interest rates, then actually stocks look about average. So this is a constant debate. But from our point of view, we side a little bit more with the with the rates argument that with rates so low, with very little alternatives to equities, then that's still an environment where equities can perform well. Okay, rates are low, but what about inflation and all those one-offs?

Evan says it's still too early to tell, that we won't know until the third or fourth quarter. I asked, if we get broader inflation at a higher rate that's sustained through the end of the year, does that mean stocks will perform poorly? Evan says it depends which stocks. If you get that inflation, if you get that bond yield rise, it's going to be a lot more disruptive for tech companies, for growth stocks, given that they're priced off this idea, essentially, that rates will never rise from here. But if we're in an environment of reflation and inflation, that's a good environment for financials. Financials will respond well to higher rates.

If we're in a broad inflation environment, then probably oil is playing a role in that. Energy stocks should respond well. So it's a matter, I think, of rotating your equity exposure to fit those different macro environments. Evan also recommends buying exposure to commodities like grains, oil, and base metals. When I say base metals, I mean the kind you build with, not the kind you wear around your neck. Those are called precious metals. But lately, base metals are becoming a lot more precious. Aluminum is up 70% over the past year, and gold, it's only up 5%.

I asked about cryptocurrency. Back in February, we mentioned that a parody cryptocurrency called Dogecoin had risen from half a penny to eight cents this year. Well, now it's over 60 cents. And if it hits a dollar anytime soon, like the Doge bulls expect, it could be worth around $130 billion. That's roughly the value of Caterpillar or Charles Schwab, neither of which, and I can't stress this strongly enough, are parodies. Evans says that the premise of Dogecoin makes him uncomfortable, which is understandable. But what about other cryptocurrencies like Bitcoin and Ethereum? Should they be considered a hedge against inflation? We don't know. I mean, I wouldn't count on it. I mean, right now, when we talk about,

is it going to add something to your portfolio? The correlation between these cryptocurrencies and the stock market has only been going up. Obviously, Bitcoin is going up a lot more than the stock market, but they're very correlated. And we've actually seen cryptocurrencies be a leading indicator for an intermittent market top. So you're all correlated to it. And it's just extraordinarily volatile. So anyone who's putting this into their portfolio, they need to keep the sizing very appropriate, given that, I mean, the thing could drop 30% in a matter of a couple of days. Evan says that investors who have a high weighting in U.S. stocks should consider

shifting more of their stock portfolios overseas. Despite all the disappointment in Europe with the extra shutdowns and what was really a botched vaccine rollout, Europe's now vaccinating more people a day than the U.S. And you're going to have other developed markets shortly behind and then you're going to have other emerging markets shortly behind that. And so if we want to be skating to where the puck is going, to use that hockey cliche, we need to be looking at those countries where there's been peak pessimism and peak negativity on Europe, for example. But the path we're heading to is undoubtedly a positive one. I think that has implications for international equities. I think it has implications for the dollar, which should weaken as you see the recovery from COVID become more global and not just U.S. driven. Take some of those Dogecoin profits and redeploy them, I think.

Matt, let's talk about retail. We're getting close to your initial public offering and I can't imagine that you've been hitting the mall stores. Have you visited any big chain stores lately? I have not, no, but I've been shopping online. I've been making regular trips to Home Depot and Lowe's and CVS and the supermarket. And in recent months, I made my first two trips to the mall since the start of the pandemic. One was to go to Dick's for Little League gear. That was a couple of weeks ago. And the other was to buy clothes for my daughter several weeks back when she returned to in-person schooling. And this is going to surprise you, but my preteen fashion game, it's not on point. So

I decided ahead of time that I would spend a wheelbarrow of cash with any salesperson who stepped forward and offered to take my daughter around the store. And two young ladies did just that. One at Hollister and another at American Eagle. So I spent two wheelbarrows of cash. And that's pretty much it for my store visits. But I saw a report this past week from a data unit of MasterCard. It's called Spending Pulse. And it said that spending in April,

not counting cars and gasoline, was up more than 23% from April a year ago. That's a healthy bounce back. But more remarkable was that spending was up more than 10% from two Aprils ago, before the pandemic. Also, I noticed that although online spending has been growing much faster than in-store spending for years, if we compare April with a year ago, in-person spending grew a little faster. In other words, people are going back to stores. And that has had a pronounced effect on stock prices. Macy's shares are higher now than they were before the pandemic. L Brands, that's the owner of Victoria's Secret and Bath and Body Works, that stock has nearly tripled since before the pandemic. Gains like that are

surprising to me. Macy's is a storied retailer, but it's also just the kind of department store that has struggled to find an answer to Amazon. Why would the pandemic, which has forced more shopping online, make Macy's more valuable? L Brands had been giving up market share for years before the pandemic. Now sales are bouncing back. The company credits, quote, unusual shifts in consumer spending patterns resulting from government stimulus payments, a relaxation of COVID-19 restrictions and other factors. OK, but will that last? B of A says the company is in the, quote, early stages of a promising turnaround. But Jeffrey says it remains unclear to what extent the recent strength will carry forward as recent tailwinds moderate. Sometimes it's hard to tell a lasting turnaround from a temporary bounce.

To learn more about sizing up retail turnarounds, I spoke recently with a man who's credited with leading a big one. Hi, Hubert. Nice to see you. How are you today? I'm doing well. I just moments ago got my microphone working after much effort. It would have been so humiliating to talk with the former chief of Best Buy and not be able to get my electronics working. Hubert Jolie was announced as the new chief of Best Buy in 2012, just as the company announced it wouldn't accept a buyout offer from its founder, and the stock dropped 10% in a day to about $18. But by the time Hubert left in 2019,

the stock price had more than tripled to $65. Just as impressive is that the stock has continued doing well since then, recently trading at $116. Before Best Buy was Best Buy, it was the Sound of Music Stereo Shop in St. Paul, Minnesota, opened in 1966. By the early 1980s, when the company had seven stores and $10 million in yearly sales, it changed its name to Best Buy, and it added appliances and other electronics like VCRs. The company later set itself apart from rivals like RadioShack by doing away with commissioned salespeople and opening big, modern-looking stores with merchandise stacked on the sales floor, not in the back room. The approach was a hit, but by the time Hubert took over nearly a decade ago, things had changed. Amazon was competing fiercely in electronics. Chains like CompUSA and Circuit City had already

been pushed out of the business. Revenues were falling at Best Buy, and there was a sense of impending doom. I asked Hubert, what did your friends say when you took the job at Best Buy, and why did you take it? So your question is, what were things like when I studied and why did so many of my friends in Minneapolis thought I was either crazy or suicidal at the time? Best Buy is this iconic, amazing company that had been successful for a long while. I'd been a vendor of Best Buy when I was in video games. But it's true that in 2012, everybody thought Best Buy was going to die. And what I saw, Jack, was the world needed Best Buy. For certain of our purchases, it's good to be able to see, touch, and feel the products

and ask questions. So customers needed Best Buy. And importantly, the vendors needed Best Buy, right? Because they spent billions of dollars on R&D and they need a place where to showcase the fruit of that investment. You know, a box on a shelf at Walmart or just a screenshot on Amazon is not going to do it. Hubert did not have retail experience when he took the job. He had turnaround experience. For example, he had restructured Vivendi's video game business, which is now part of Activision Blizzard. He says that when he looked into Best Buy, many of the problems appeared self-inflicted. Prices were not competitive. The online experience

was not great. Speed of shipping was terrible. And the stores had become miserable. So that convinced me that, you know, if strategically things were fine, but, you know, the problems were self-inflicted, then we could do a turnaround. Hubert made investments to improve the online shopping experience and speed up shipping, and he empowered his store workers, the blue shirts, as he calls them, to match Amazon prices. That brought the company to what he calls a draw with Amazon. And he says investors told him, that's nice, but you're still going to die because your cost structure is higher than Amazon's. Then Hubert introduced a strategy

that brings to mind, not Amazon, but maybe a company like travel booker Expedia, which makes money from its vendors by connecting them with its customers. Best Buy already had Apple sections in its stores. Hubert met with another key vendor, Samsung, and came up with a plan to highlight Samsung products in their own special section in Best Buy stores. He says it was good for customers because they could compare Apple and Samsung products side by side. And good for Samsung because it could quickly build a bigger retail presence. And it was good for Best Buy because it brought in new business. And Samsung paid for things like fixtures, display inventory, some of the labor and the marketing. That was a game changer. And our share price went up

23% when we announced that deal. And then all of the other tech companies wanted to do the same. Microsoft followed, Sony, LG, and even Google and Amazon. Amazon now has a store within a store table where they can showcase their Echo Alexa products. products. The stock gain helped in winning credibility with investors. I asked Hubert, how did you get buy-in from employees? He says he spent his first week in the job working in a store learning from frontliners. Why? Because in a short period of time, I was able to learn from the frontliners, which was not working from their standpoint, so on the front line, and for them to tell me what they needed. It would have been much harder to figure it out from a windowless conference room looking at spreadsheets, but there it was really clear. It was about our search engine not working, our prices not being competitive, and then

of course then following up and addressing their needs. So here's an example. It was incredibly symbolic. The previous management team had reduced the employee discount. At the same time, the board had put in place stay bonuses for the senior executives so that they would stay while they were looking for a new CEO. Imagine what it's like for the frontliners. They were furious. So they told me.

I went back to headquarters. I talked with the team and said, what should we do? We decided to reinstate the employee discount. And then all of the other investments in the tools for them, empower them to match Amazon prices was a huge thing. I asked Hubert whether he thinks Best Buy's turnaround can last from here, and he said yes, because it's no longer just an electronics retailer. He says it's a company driven by addressing key human technology needs, whether that's helping seniors stay in their homes longer or helping homeowners install smart lighting systems. Hubert says no home is monobrand, not even the home of Apple chief Tim Cook. Everyone

needs help integrating devices. And Hubert says current management at Best Buy is doing an excellent job. If you want to learn more about Hubert's approach to management, he's written a book about it. It's called The Heart of Business. It was strategically displayed during our video call and I asked him about it. So what I like about your backdrop there is the way it draws the viewer's eyes to the heart of business, strategically displayed. Here's a man who knows something about product display. Yeah, and the book is so timely, right? Because I think we can quickly agree that our world is facing multiple crises, a multifaceted crisis, of course, a health crisis, but economic crisis, societal crisis,

racial crisis, environmental crisis, geopolitical tensions, you name it. And Jack, what's the definition of madness, right? Doing the same thing and hoping for a different outcome. That was, of course, Albert Einstein. For me, on my FBI most wanted list, there's two people. Milton Friedman, which I think was a disease with this exclusive focus on profits, and Bob McNamara, the former Secretary of Defense, who invented at Ford scientific top-down management. You tell other people what to do, you measure, and you expect compliance. These things don't work. In fact, they're dangerous. Hubert says there's a better formula than what he characterizes as Friedman's narrow focus on profits. He says it's about pursuing a noble purpose and putting people at the center.

For example, he says everyone wanted him to close stores and cut workers when he started, but instead he invested in stores and cut costs in other ways. For example, he says Best Buy was breaking $200 million worth of big screen TVs each year for mishandling them. So cutting that in half could save a lot. Finally, I asked Hubert to tell me something that investors can use when sizing up potential turnarounds. How do you tell which ones have the minimum ingredients necessary to succeed? I think a great question is, does the world need that company? And is there anything structural that cannot be overcome that would lead that company to die? As an example, I remember when I was a McKinsey consultant, I had a client in the steel industry. The break-even

point for that particular steel mill was higher than the capacity of the steel mill. So nothing you can do, right? But if the world needs the company, you have to look at it with a different set of lenses than just cut, cut, cut. It's really hard to cut yourself to prosperity. Thank you for listening. Meta Lutsoft is our producer. Meta, I know I've been talking too much about baby stuff, but one of the best things about babies is that you can wear them in a little pouch thing right in front of you and just lean over anytime you want and just you sniff their little heads. It smells like a cross between hope and nap time. It's like aromatherapy.

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