Best Buy's Turnaround is Much Further Along Than J.C. Penney's

For the first time since 2012, consumer electronics retailer Best Buy has raised its dividend. The new $0.19 quarterly dividend represents a 12% boost, and CEO Hubert Joly cited an improved cash position and confidence in the company's cash-generating power as reasons behind the move.

While investors always love a dividend boost, how does this higher dividend payment affect Best Buy's turnaround effort?

A different kind of turnaround
Best Buy's turnaround has been unique in that the company never became unprofitable, even in its worst year. Net income was negative in fiscal 2012, but this was due to big write-offs. Free cash flow, often a better measure of a company's health, was always positive, and the company managed to avoid needing to slash its dividend.

This is very different from the turnaround efforts of other struggling retailers. Department store J.C. Penney , for example, was forced to suspend its dividend in 2012, as free cash flow turned negative and debt began to pile up. Because Best Buy managed to remain free-cash-flow positive, it didn't need to take on loads of debt to fund its turnaround, and the company's financial position has greatly improved since Joly took the helm in late 2012.

As of the most recent quarter, Best Buy had about $3.1 billion in cash and $1.6 billion in debt, leaving a net cash position of roughly $1.5 billion. This is a dramatic change from a few years earlier, when Best Buy had more debt than cash thanks to aggressive share buybacks in the years leading up to Joly's appointment. Free cash flow was $547 million in 2013, lower than in previous years but still soundly positive.

Contrast this with J.C. Penney's current financial position. At the end of the most recent quarter, J.C. Penney had $1.2 billion in cash and $5.5 billion in debt, and the free cash flow in 2013 was a loss of $2.77 billion. A significant portion of this debt was added during 2013 to fund the turnaround effort, something that Best Buy didn't need to do.

The point of this comparison is to show that all turnarounds are not created equal. As an investor, I much prefer a company that can execute a turnaround plan while both remaining profitable and avoiding excessive debt. The chance of success is much higher that way, and Best Buy's dividend hike is a sign that the worst for Best Buy, which wasn't even that bad relative to J.C. Penney, is over.

What the dividend hike means
A company should pay a dividend -- let alone raise that dividend -- only when it is generating more cash than it needs. The fact that Best Buy feels confident enough to raise its dividend indicates that the major investments that the company needed to make during its turnaround are mostly in the past.

The dividend hike could also signal that Best Buy has enough cash in the bank to consider a share-buyback program in the near future. Since the company has remained cash-flow positive, the amount of cash on its balance sheet is going to keep piling up, and while management has expressed its desire to build a fortress balance sheet, letting excess cash sit idle while the stock remains undervalued is not ideal.

With the newly raised dividend, Best Buy will pay out about $265 million in dividend payments over the next year. This is less than half of the free cash flow from 2013, and Best Buy has enough cash to cover these payments more than 11 times over.

The bottom line
Any fear that Best Buy is in financial trouble should by allayed by the company's decision to raise the dividend. While Best Buy does operate in a highly competitive industry, the company has managed to counter the negative effects of having to lower its prices with aggressive cost cutting, and continued profitability coupled with a strong balance sheet means that Best Buy can easily afford this dividend boost. While some investors have likely stayed away from Best Buy due to uncertainty, this dividend increase marks a great time to take another look at the stock, especially given that it currently sits well below the highs of earlier this year.