Best Buy’s Earnings Improve On Its Turnaround Strartegy

Electronics retailing giant Best Buy (NYSE:BBY) reported its third consecutive quarter of better than forecast earnings and posted its first quarterly profit in a year, in Q2 2014. With over 1.6 billion visitors to its websites and stores every year Best Buy is the largest specialty retailer of consumer electronics in the U.S. However, the growing competition from retail giants including Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT) has hurt Best Buy’s business in the last few years.

Despite its ongoing price matching policy, Best Buy earned $9.3 billion in revenues (almost flat y-o-y) and saw its gross margin increase from 24.2% in Q2 2013 to 26.5%. However, not accounting for the non-recurring items the non-GAAP gross margins declined by 0.6% annually. Nevertheless, the company believes that gross margins bottomed out this quarter.

In the last 10 months, Best Buy is focusing on tackling the decline in its comparable store sales and eroding operating margins. It made progress on both parameters this quarter. A stabilizing revenue base and improving margins increased the company’s net income from continuing operations to $237 million compared to $31 million an year ago.

Best Buy continues to shut down its under-performing stores and revamp existing stores to enhance the customer buying experience. The encouraging Q2 2014 earnings lifted its stock price by more than 13%. While the strong turnaround strategy and improving financials are encouraging, we remain cautious on the company’s outlook until we see a sustainable improvement in its top line and profitability.

See our full analysis for Best Buy

Quick Snapshot Of The Q2 2014 Results

Best Buy reported a significant jump in its diluted EPS from continuing operations from $0.09 in Q2 2013 3to $0.69 in Q2 2014. Excluding the impact of $229 million received in legal settlements, restructuring charges, non-restructuring asset impairments, gains on sales of investments and the tax impact from the sale of its European business, the diluted EPS increased marginally from $0.26 to $0.32. The EPS increase was driven primarily by strong expense management and Renew Blue cost savings, partially offset by higher investments and price competitiveness.

Best Buy’s domestic revenue increased by 0.1% (y-o-y) as the company earned incremental revenue from 57 new Best Buy mobile stores which was offset by a comparable store sales decline of 0.4%. The retail deployments of the Samsung Experience shops, Windows stores floor space optimization, as well as the rationalization of its non-core businesses led to the marginal decline in comparable stores sales. Excluding the above the domestic comparable store sales were flat, which marks a considerable improvement over the 3.3% decline in Q2 2013.

The domestic online comparable revenue climbed by 10.5% on account of increased traffic and a higher average order value including gaming pre-orders.

International revenue declined by 2.9% as Best Buy shut 15 large format stores in Canada last year. The international comparable store sales declined by 1.8% on account of lower consumer electronics demand and the ongoing competitive pressure in Canada, though the company witnessed higher consumer demand from China due to expiring government subsidies that were supported by increased promotional offers.

On account of its exit from the European market combined with its proactive working capital management, Best Buy expanded its cash balance to $1.9 billion in the quarter.

Positive Progress Made Through The Renew Blue Program

At the start of this year, Best Buy outlined six key initiatives under the “Renew Blue” program to turn around the company – accelerating online growth, enhancing the multi-channel customer experience, increasing revenue and gross profit per square foot to enhance store space optimization and merchandising, driving down cost of goods sold for supply chain efficiencies, continuing to gradually optimize the U.S. real estate portfolio and further reducing SG&A costs. Best Buy claims to have made progress in each of these initiatives and intends to continue investing in the same for the rest of the calendar year.

Accelerating growth in its online segment remains one of the main focus for Best Buy as it aims to update its website to get on par with Amazon and other competitors. Best Buy intends to increase online traffic and increase the conversion rate among visitors by providing a more interactive shopping experience and is taking a number of initiatives to see measurable improvements in the customer experience. Its Net Promoter Score (NPS), a new metric to track customer satisfaction levels, improved by approximately 3% (y-o-y) in Q2 2014.

To enhance store space optimization and merchandising, Best Buy entered into a partnership with Microsoft (NASDAQ:MSFT) to open the latter’s stores within the company’s brick-and-mortar outlets, in June 2013. Microsoft is the third tech giant after Apple (NASDAQ:AAPL) and Samsung (PINK:SSNLF) to have a dedicated selling space within Best Buy stores. Best Buy claims to have witnessed a good response for these stores so far. However, the deployment of the Microsoft stores is more disruptive than the initial work on the Samsung Experience shops and thus we can expect them to offset top-line growth till Best Buy completes the deployments of the project.

In March 2013, Best Buy put in place a permanent “Low Price Guarantee” policy under which it will price match all local retail competitors and 19 major online competitors in all product categories and on nearly all in-stock products, whenever asked by a customer. The company will focus on making its price more competitive though improved analytics over the next several quarters. Though the lower prices enhances Best Buy’s competitiveness in the market it puts pressure on its bottom line.

Best Buy is in the process of rolling out the Renew Blue program in Canada and China as well.

We are in the process of updating our price estimate for Best Buy.

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