OREANDA-NEWS. Fitch Ratings has upgraded its long-term Issuer Default Rating (IDR) on Best Buy Co., Inc. (Best Buy) to 'BBB-' from 'BB'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS
The upgrade reflects Fitch's expectation that management's successful focus on higher margined products and services, coupled with expense reductions, will allow annualized EBITDA to remain at or above $2 billion. At this level, leverage is reasonable in the 3x range and Best Buy would generate $500 million to $700 million in free cash flow (FCF; post dividends) annually.

Market Share Stabilization: Best Buy is using its real estate assets, broad product offering and existing services infrastructure to strengthen customer relationships and capitalize on anticipated growth in the connected home business. These efforts are supported through strategic partnerships with key vendors, and Fitch expects these partnerships to expand over time. Management has also positioned the business to capture share in the growing online channel through its distribution infrastructure and omnichannel capabilities. Same store sales have stabilized in recent quarters, and Fitch expects flattish domestic comps over the next 12-18 months.

Expense Structure Efficiency: Management has announced over $1.4 billion in expense reductions, and savings are being reinvested into growth initiatives and sharper prices. Cost management allowed Best Buy to generate an over 10% EBITDA increase to $2.2 billion in 2014 despite slight declines in sales and gross profit. Continued implementation of these reductions should support its pricing position and EBITDA through 2016.

EBITDA Improvement: The above efforts resulting in a more than 10% increase in 2014 EBITDA after several years of declines, suggest management initiatives are proving successful. YTD 2015 EBITDA improvement is further evidence and, at a consistent EBITDA of $2.2 billion, leverage would fall to the high 2x range.

In recent years, Best Buy has experienced sales declines related to both secular trends in key categories as well as strengthened competition from lower-priced players and online merchants. In 2012, management began a multi-year program to address both issues. This 'Renew Blue' program includes the following: growing categories where Best Buy believes it has a competitive advantage, reducing selling prices using cost savings, and investing in the online experience and distribution capabilities.

Best Buy is exposed to key categories, including computing and flat panel televisions, which have been in secular decline. The company has lower market share in categories experiencing higher growth, such as mobile and appliances. As a result, Best Buy has invested in these growth categories through square footage reallocation and strategic partnerships to showcase key vendors. The company has also invested in its higher-margin services business as a complement to its broad product offering. Fitch believes the service component and Best Buy's real estate assets are true differentiators against lower priced and online-only peers, and allow Best Buy to strengthen customer loyalty and product/service bundling, particularly as the connected home market grows.

To further address discounter competition, management has lowered prices with minimal EBITDA impact as it reinvests savings from its $1.4 billion expense management initiative. Fitch estimates these cost reductions could enable a 3% average price investment across Best Buy's assortment, though expects the price investments are more strategically targeted.

Finally, Best Buy is addressing online shopping migration with investments in customer experience, distribution capabilities, and omnichannel efforts. Unlike online-only peers, Best Buy can leverage its real estate to offer faster shipping, improved product availability and in-store pickup.

KEY ASSUMPTIONS

-- Fitch expects flattish domestic comps over the next 12-18 months.
-- EBITDA is expected to remain at or above the $2 billion level and leverage to linger at around 3x.
-- Fitch expects Best Buy to generate FCF (post dividends) at around $700 million in 2015 and $500 million-$700 million thereafter. Fitch expects FCF will be increasingly deployed towards its recently resumed share-repurchase program.

RATING SENSITIVITIES
Negative Rating Action: A downgrade could be caused by worse-than-expected sales declines of negative 2% or more for the domestic business versus Fitch's flattish projections or material gross margin decline without any significant offset from cost savings, resulting in EBITDA declining below $1.8 billion and therefore adjusted leverage increasing towards mid-3x. A downgrade would also result from growth deceleration in Best Buy's focus categories, including mobile, appliances, and services.

Positive Rating Action: Fitch would need to see sustained momentum in comps trends (+2%-3%) and EBITDA (near $2.5 billion) yielding leverage near 2.5x, predicated on either market share gains or stabilization in consumer electronics trends, to consider a positive rating action.

LIQUIDITY
Best Buy ended 2014 with $3.9 billion in cash and short-term investments, having generated $1.1 billion in FCF (post dividends) during the year. Additionally, the company has full availability on its $1.25 billion domestic credit facility. Fitch expects Best Buy to generate FCF (after dividends) of around $700 million in 2015. Flattish same store sales should allow the company to generate $500 million-$700 million in FCF in 2016/2017. Fitch expects FCF will be increasingly deployed towards its recently resumed share-repurchase program.

The next maturity of unsecured notes is March 2016, which Best Buy could refinance or pay down with cash on hand.

FULL LIST OF RATING ACTIONS

Fitch has upgraded its ratings on Best Buy as follows:

--Long-term IDR to 'BBB-' from 'BB';
--$1.25 billion bank credit facility to 'BBB-' from 'BB/RR4'; and
--$1.50 billion senior unsecured notes to 'BBB-' from 'BB/RR4'.