Best Buy Earnings Disappoint Ahead of a Crucial Period

For U.S. retailers, it’s go time. The back-to-school shopping period has just ended, and the all-important holiday shopping season is about to begin. This is the time of year that retail stocks show what they’re made
But for Best Buy (NYSE: BBY), these are no easy times. For several years, the company has fought through a number of challenges, including price deflation in electronics and the feared “show-rooming” phenomenon. This describes the trend of consumers going into Best Buy stores to view products in person and ask questions to staff, only to return home to buy the item cheaper online.
This has taken Best Buy’s growth, and by extension its shareholders, on a wild ride over the past few years. The stock has swung wildly between $40 and $10 and back again in that time.
On Thursday, the retailer released quarterly earnings that were quite satisfactory on a number of metrics. However, investors seemed to focus more on the negatives, and the stock fell 5% after the Best Buy earnings report was released and closed the day down 2%.

Beauty Is in the Eye of the Beholder

There was a lot to like from Best Buy’s quarter. Earnings per share from continuing operations of $0.37 significantly exceeded Wall Street projections of $0.30 per share. On a year-over-year basis, earnings grew 12%, which is a strong number in an otherwise weak climate for retailers.
Best Buy’s strong profitability was due largely to its huge cost-cutting efforts. This helped gross profit margin rise more than one full percentage point in the domestic segment last quarter.
However, investors were more focused on Best Buy’s sales figures, which were poor. Total revenue fell 2.3%, to $8.82 billion, just shy of the $8.83 billion analysts expected. Comparable-store sales, a critical measure that keys in on sales at stores open at least one year, rose 0.5% last quarter. This fell below analyst expectations, which called for a 0.8% increase.
Once again, the usual culprits – TVs and PCs – weighed on Best Buy’s sales. Pricing in televisions has come down dramatically in recent years, due to oversupply and massive discounting necessary to move inventory. As far PCs, the erosion in the global PC industry should come as no surprise.
Global PC shipments fell 10% last quarter, an even worse decline than analysts had expected. As consumers at both the individual and enterprise levels conduct a greater share of computing on mobile devices and smartphones, sales of PCs are collapsing this year.
As a major electronics retailer, this is a huge problem. Still, Best Buy remains optimistic about the upcoming holiday shopping season.

Gearing Up for the Holidays

In order for Best Buy to succeed this quarter, strong execution will be critical. Best Buy plans to do that by aggressively building up its e-commerce business in order to get inventory out quickly.
Best Buy’s digital sales channel grew comparable sales by 18% last quarter. Online sales were a major growth catalyst last quarter, and will likely be one again this quarter. Best Buy’s digital efforts are helping to drive traffic both online and in-store.
Another reason why Best Buy is optimistic about the holiday shopping season is because it is expanding its lineup of health and fitness wearable devices. Best Buy began selling the Apple (NASDAQ: AAPL) Watch this fall, which could be a sales driver this quarter.

A Critical Time Is Fast Approaching

Best Buy will need to have a strong holiday shopping season in order for its stock to regain some positive momentum. But at least the stock is cheap. Best Buy shares trade for just 12 times earnings, a significant discount to the S&P 500. And Best Buy also offers shareholders a nifty 3% dividend.
The company is facing a make-or-break period, but the good news is that expectations are fairly low. At such a cheap valuation and a market-beating dividend yield, investors at least have a margin of safety.
DISCLOSURE: Bob Ciura personally owns shares of Apple (NASDAQ: AAPL).

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