Best Buy’s Earnings: Turnaround Will Not Show Big Gains Just Yet

Electronics retailing giant Best Buy (NYSE:BBY) will report its Q2 2014 earnings on August 20. 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 restricted Best Buy’s business in the last few years. In addition, the company’s decision to exit the European market has impacted top-line growth in the last few quarters.

Best Buy saw a marginal decline in its Q1 2014 earnings if we include the results from its discontinued operations in Europe and reported a net loss of $81 million after accounting for a loss of $178 million in discontinued operations. The company undertook a number of initiatives to turn around its business – the price matching policy, partnerships with Samsung (PINK:SSNLF) and Microsoft (NASDAQ:MSFT), the Renew Blue Program, etc. While these initiatives might be successful to spur Best Buy’s long-term demand, we remain wary of its short-term outlook and do not expect to see any significant turnaround in Q2 2014.

See our full analysis for Best Buy

Exiting Europe Will Negatively Impact Revenue Growth

In 2008, Best Buy entered into a joint venture with Carphone Warehouse, Europe’s biggest independent mobile phone retailer, to tap the growth potential in the region. However, Best Buy announced its decision to sell its 50% stake in the venture in April this year. Marking its exit from the European market, the deal signals that the retailer is more keen to focus on enhancing its competitiveness in the domestic U.S. market where it is facing formidable challenges from players like Wal-Mart and Amazon.

Best Buy needs a strong balance sheet to meet its expansion targets in the U.S., and this deal seems to be a step in that direction. We think that the cash from the Carphone Warehouse transaction will be used to further expand Best Buy mobile and make investments in altering the product mix at its outlets.

Prior to entering into this agreement, U.S. GAAP revenues for Best Buy Europe in the ongoing fiscal year were expected to be in the range of $5.5-$5.6 billion. Hence, by virtue of a 50% stake, the impact on Best Buy’s revenues this year will be around $2.8 billion.

Renew Blue Program Can Help Turnaround The Business

Last quarter, Best Buy outlined certain key initiatives under the “Renew Blue” program to turn around the company. 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. That means keeping track of user preferences based on their browsing history and generating recommendations accordingly. In Q1 2014 it took various initiatives – the deployment of best-in-class search engine marketing tools, higher investments in paid search, expanding its affiliate marketing channel – which resulted in a 16% increase in domestic comparable online sales during the quarter.

Best Buy aims at enhancing customer experience across channels – in-store and online. It has unveiled a new metric called the Net Promoter Score (NPS) to track customer satisfaction levels with the company’s service. This is measured for all customers whether they choose to buy from the company or not. Best Buy claims that the customer satisfaction levels with its sales associates, service and price perception have improved since it introduced the NPS in November last year. Quantitatively, the NPS has shown a 300 basis point growth.

In June this year, Best Buy entered into a partnership with Microsoft to open the latter’s stores within the company’s brick-and-mortar outlets. Microsoft will be the third tech giant after Apple (NASDAQ:AAPL) and Samsung to have a dedicated selling space within Best Buy stores.

Declining Gross Profits

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. This guarantee is available on Best Buy’s website at more than 1,000 Best Buy big box stores, more than 400 Best Buy Mobile standalone stores in the United States, as well as on the telephone.

The policy is an attempt by the company to tackle the problem of showrooming, the phenomenon of potential customers using brick-and-mortar stores to browse through products only to order them online at cheaper prices. As a result of Best Buys’s price matching policy along with its ongoing investment to revive its business, its gross profit margin declined from 24.9% in Q1 2013 to 23.1% in Q1 2014.

Best Buy has pledged to reduce its business costs and is aiming to reduce its cost of goods sold by $325 million through supply chain efficiency and modification of its return and replacement policy. To date, it has managed to generate savings worth $30 million. Best Buy had also pledged to reduce its SG&A costs by $4oo million in North America this year and claims to have made good progress so far. In Q1 it eliminated $135 million in SG&A costs and announced further reductions worth $150 million in March.

Additionally, in order to improve gross profit per square foot, Best Buy is focusing on stocking more items that generate higher margins. Therefore, it has reduced the stock of CDs and DVDs in its stores and is allocating  more store space to mobile and computing products.

Despite these initiatives, we expect the intense competition in the industry to keep margins under pressure over our review period.

We will update our price estimate after the Q2 2014 earnings release.

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