Best Buy’s Q2’15 Sales To Be Impacted By The Weak Consumer Electronics Market But Long-Term Prospects Remain Positive

The largest specialty retailer of consumer electronics in the U.S., Best Buy (NYSE:BBY), will report its Q2 2015 earnings on August 26. (Fiscal years end with January.)  A weak consumer electronics market, as well as 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. Though revenue ($9 billion) declined by 3.3% annually in Q1 2015, meaningful progress against the Renew Blue priorities (its restructuring program) resulted in a better than expected non-GAAP operating margin of 2.3% in the quarter.

Best Buy expected its same-store sales to decline in Q2 and Q3 2015 on account of lower expected industry-wide sales in many of the consumer electronics categories the company sells. The company reports that the forecaster NPD expected the consumer electronics industry to decline by 2.6% in Q2 2015. Best Buy expects its cost cutting efforts to offset the weaker sales and costs related to its price matching policy. The company remains confident that its growth will re-accelerate in the next few years as it continues to make progress on its turnaround strategy.

We will update our $26 valuation for Best Buy after the Q2 2015 earnings release.

See our full analysis for Best Buy

Significant Progress On The Renew Blue Program Will Help Re-accelerate Growth

Introduced in 2013, Best Buy’s “Renew Blue” program is the company restructuring initiative 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. The company’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 in Q1 2015.

– Merchandising: Best Buy continues to add differentiated in-store customer experiences in several key categories, including appliances, home theater and mobile. Last quarter, 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 Q2 2015. 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 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. 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. (Read: Best Buy To Benefit From Increasing Online Sales)

– 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 Initiatives To Ease Pressure Off Margins

Best Buy’s innovative schemes to re-accelerate its business have impacted its gross margins,w hich declined from 23.2% in fiscal 2012 to 22.8% in fiscal 2014. In Q1 2015, Best Buy’s gross margin declined by 75 basis points (to 22.4%). The company is still in the transitory phase, and thus its gross profit is expected to remain under pressure due to a number of factors.  These include not only competitive pricing, lower sales, and incremental investment in pricing and the Renew Blue SG&A program, but in additional expenses related to mobile warranty programs and the new credit card agreement. However, Best Buy has taken a number of steps to lower its cost burden, which can ease the pressure off margins to some extend. Though we forecast Best Buy’s gross margin to continue declining, we anticipate a lower rate of decline compared to the past.

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 [↩]