Best Buy Suffers From Lower Electronic Sales, But Cost Savings Improve Profits

The largest specialty retailer of consumer electronics in the U.S., Best Buy (NYSE:BBY), reported its Q1 2015 earnings on May 22. Though revenue ($9 billion) declined by 3.3% annually, meaningful progress against the Renew Blue priorities (its restructuring program) resulted in a better than expected non-GAAP operating margin of 2.3%. Best Buy’s non-GAAP diluted earnings per share increased from $0.32 in Q1 2014 to $0.33 in Q1 2015. The enterprise gross profit margin declined by 75 basis points due to a number of factors that include: 1) the less favorable ongoing economics of the new credit card agreement; 2)  the absence of proceeds from legal settlements in the quarter; 3) increased product warranty costs primarily relating to the mobile category; and, 4) structural investments in price competitiveness. Yet the opex burden decreased by 105 basis points, enabling a 30 basis-point increase the the operating margin

A weak consumer electronics market, as well as 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. After witnessing a significant decline in its top line in fiscal 2013, the company saw its growth re-accelerate in fiscal 2014, as it benefited from its restructuring initiative. Best Buy expects its same-store sales to decline in the next two quarters on account of lower industry-wide sales in many of the consumer electronics categories the company sells. According to NPD, the consumer electronics industry will decline by 2.6% in Q2 2015. However, Best Buy expects its cost cutting efforts to offset the weaker sales and costs related to its price matching policy.

Best Buy remains 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.

Our price estimate of $26.38 for the company is in line with the current market price. We are in the process of updating our valuation for the company.

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Renew Blue Program

Introduced at the start of 2013, Best Buy’s “Renew Blue” program is targeted at the following areas:   merchandising, marketing, online stores, Geek Squad services, supply chain, cost structure and employee engagement. Best Buy claims to have made progress in each of these initiatives and intends to continue investing in the same in fiscal 2015 as well.

Best Buy’s Net Promoter Score (NPS), which measures satisfaction levels for both customers that buy and don’t buy its products, increased 2.5% year over year.

– Merchandising: In Q1 2015, Best Buy continued to add differentiated in-store customer experiences in several key categories, including appliances, home theater and mobile. It opened two new Magnolia design center stores -within-a-store and aims to add around 20 more by the end of this year. Pacific Kitchen & Home and Magnolia design center stores-within-a-store have outpaced the company’s initial expectations. In the mobile category, Best Buy introduced the selling of new installment billing plans with Sprint and Verizon in Q1 2015, and started selling AT&T’s plans in the ongoing quarter. It claims that customer adoption of these plans has been growing. Best Buy is now the only national retailer to launch installment billing plans with multiple carriers.

– Marketing: Best Buy is focusing on evolving its marketing strategy to more targeted, personalized and relevant customer communication, including the continuing to shift away from traditional TV advertising to more relevant digital marketing. It has been working on a big data project called Athena that will shift its marketing effort to more personalized email messages and offers, which will enable a more targeted approach to customer marketing. This is one of Best Buy’s key growth initiatives for the next two years. Best Buy has one of the largest repositories of customer data derived from individuals’ past purchases, browsing histories, locations and demographics. By launching project Athena, the company aims to better engage its customers for its loyalty program and credit card offering. The Athena initiative is still at a very early stage and Best Buy expects to see improvements in marketing effectiveness every quarter.

– Accelerating online sales: 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 (NASDAQ:AMZN) and other competitors. As a percentage of total domestic revenue, online revenue increased 190 basis points in Q1 2015, to 8.2% versus 6.3% last year. At $639 million, domestic online revenue increased 29.2% on a comparable basis due to substantially improved inventory availability made possible by the chain-wide rollout of the ship-from-store capability, a higher average order value, increased traffic driven by greater investment in online digital marketing, and a higher number of online orders being placed in its retail stores.

Last year, Best Buy initiated a pilot ship-from-store approach (in 50 stores) which enables all its distribution centers, and not just the ones previously allocated to e-commerce, to handle online orders. The company claims that 2% to 4% of its online traffic does not result in a purchase because it does not have the inventory in its distribution centers, but around 80% of the time the stock is available in one or more of its retail centers. ^[1] Best Buy has now rolled out ship-from-store to over 1,400 stores.

In the next 24 months Best Buy aims to further improve its online shopping experience by enhancing search tools, recommendations, and product and price information to make it easier for customers to find and choose products.

– Changes to the field and store structure: Best Buy has consolidated and simplified its field organizational structure, which is now reorganized around key markets with the goal of having the local strategy for each of those markets. It has also reduced the number of management-level roles within the stores. Though it has increased the percentage of retail labor that is customer-facing, it has managed to lower its labor cost.

– Cost reduction: Best Buy aims to reduce its cost of goods sold by increasing its supply chain efficiency and modifying its return and replacement policy. Having exceeded its cost reduction target of $725 million in Q4 2014 (it delivered cost reductions of $765 million in the quarter), Best Buy has increased its Renew Blue cost reduction target to $1 billion. In Q1 2015, Best Buy eliminated an additional $95 million in annualized cost, taking the total Renew Blue cost reductions to $860 million. Excluding the impact of the increased mobile warranty expense, Best Buy’s cost savings and other operational improvements have materially offset its price matching policy and other Renew Blue investments.

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1. Best Buy Enables Online Fulfillment from All DCs, Pilots Ship-from-Store, Retail Info Systems, July 1, 2013 [↩]