Dismal Holiday Sales To Pull Down Best Buy’s Q4’14 Earnings

Electronics retailing giant Best Buy (NYSE:BBY) will announce its Q4 2014 and full year earnings on February 27. The growing competition from retail giants including Amazon (NASDAQ:AMZN) and Wal-Mart (NYSE:WMT) has eroded Best Buy’s top line growth in the last few years. Though the company has come out with innovative schemes to re-accelerate its business, the move has impacted its gross margins, which in turn put pressure on its bottom line. However, with its restructuring initiative underway, Best Buy’s financial performance has improved in the last three quarters.

Best Buy reported a 2.6% decline in its 2014 holiday sales (9 weeks ending January 4, 2014) compared to the same period last year. Heavy sales promotion, combined with a weak consumer spending environment in the last three months, led to a 0.9% annual decline in Best Buy’s domestic comparable store sales. The aggressive promotional activity in the retail industry failed to accelerate industry demand and had a deflationary impact on Best Buy’s revenue.

Best Buy claims that its business was also hurt by supply constraints for key products, a drop in customer traffic and a disappointing mobile phone market. According to research firm NPD Group, consumer electronics sales fell 2.4% to $22.9 billion during the 9-week holiday period. ^[1]

Despite the discouraging holiday season, the company is confident that its turnaround strategy will re-accelerate its growth in the future. It claims to have made significant progress against several Renew Blue priorities, which it believes leaves it well-positioned to enter fiscal 2015.

Our price estimate of $27.84 for Best Buy is at a 10% premium to the current market price. We will update our valuation after the Q4 2014 earnings release.

See our full analysis for Best Buy

Renew Blue Program To Help Turnaround The Business

At the start of 2013, Best Buy outlined six key initiatives under the “Renew Blue” program to turn around the company. Keeping in mind the slow holiday season, Best Buy is stepping up its restructuring initiative to turnaround its business.

– Accelerate online sales: Accelerating growth in its online segment remains one of the main focus points for Best Buy as it aims to update its website to get on par with Amazon and other competitors. The company currently derives less than 10% of its store revenues from online sales. It intends to increase online traffic and increase the conversion rate among visitors by providing a more interactive shopping experience. Its initiatives resulted in 23.5% growth in comparable online domestic sales during the 2014 holiday season.

– Improve & innovate the multi-channel customer experience: Best Buy has introduced 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 considerably since it introduced the NPS in November 2012. The company claims that its NPS improved by 400 basis point which resulted in a market share gain during the 2014  holiday season. ^[2]

In addition to the above key priorities, Best Buy intends to enhance its marketing approach and effectiveness (particularly relating to personalization, targeting of customer segments and buying occasions), as well as reinvigorate and grow its Geek Squad services business. It made a greater-than-expected investment in pricing in the holiday period and intends to continue investing through the end of Q4 2014.

Gross Margins To Remain Under Pressure

As a result of Best Buy’s “Low Price Guarantee” policy, its gross profit margin declined from 24.8% in fiscal 2012 to 23.2% in Q3 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. As of January 16, it eliminated an additional $45 million in annualized costs, which brings its total annualized Renew Blue cost reductions to $550 million. Best Buy also pledged to reduce its SG&A costs by $4oo million in North America by the end of fiscal 2014.

Additionally, in order to improve gross profit per square foot, Best Buy is focusing on stocking more higher margin merchandise. To this end, 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.

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1. Best Buy holiday sales fall, shares skid, appealdemocrat.com, January 16, 2014 [↩]
2. Best Buy Announces Holiday Revenue Results, Best Buy Press Release, January 16, 2014 [↩]