Best Buy Reports Positive Results Too, But Remains Cautious About FY’16

The 2014 holiday season started with low market expectations and some concerns raised by industry experts about the impact of aggressive discounting to which retailers are resorting. According to the NRF foundation, sales in November and December can account for as much as 30% of a retailer’s annual sales, and make up nearly 20% of the industry’s annual sales. Historically, analysts and investors have used holiday sales as an indicator of the overall health of the US economy. However, as a result of early online promotions by e-retailers, customers now make purchases over an extended period, starting as early as November, driving the sales down during the Thanksgiving holiday.

US Holiday Sales Register Highest Yearly Growth Since 2005

To the market’s surprise, this holiday season registered a year-over-year growth of 4.6%, the highest since 2005, beating the expectations for a 3.8% rise, according to ShopperTrak, which surveys spending at brick-and-mortar stores ^[1]. Retailers including Barnes & Noble and J.C. Penney announced their holiday sales numbers last week and exceeded expectations, with the former’s stock price jumping 20% after the sales release.

Best Buy Joins The Party With Positive Holiday Results

Best Buy (NYSE: BBY) came out yesterday with their holiday sales numbers and reported a 2.1% growth in enterprise sales and a 2.6% domestic comparable sales increase, excluding the 80-basis point estimated benefit of installment billing.  President and CEO Hubert Joly said that large screen televisions and mobile phones were the primary drivers of the year-over-year revenue growth, more than offsetting the industry-wide decline in tablet sales. This weakness in tablets, which as a category has a strong online penetration, affected online comparable sales and resulted in a growth of 13.4% compared to 23.5% last December. However, on the positive side, the growth was driven by increased online traffic and higher conversion rates.

Caution about a challenging FY16 results in a knee-jerk reaction from the market

In order to adapt to an industry that has been going through structural changes, Best Buy is beginning to make the incremental investments in inventory availability, the supply chain and more relevant marketing. Joly says that these structural changes are caused by external pressures including deflationary pricing, declining demand and exchange rate volatility. While he is confident about overcoming these challenges, he expects the investments in the growth initiatives to put year-over-year pressure on non-GAAP operating income rate beginning as early as Q1 FY16. Also, he indicated that the positive domestic sales trends seen during the holiday period were partially driven by the excitement around high-profile products and will not likely continue at holiday levels.

These views led to a sharp decline of 14% in BBY’s stock, which places our price estimate of $33 at an approximate 5% discount to the current market price.

See our full analysis for Best Buy

Best Buy Has A Tough Battle Ahead, Against Amazon

Best Buy is up against Amazon in retaining its share of the consumer electronics market and has been providing customers with a price match guarantee to limit the practice of showrooming (browsing in stores and buying online). While this might help boost Best Buy’s sales up to a certain extent and provide short term sales growth, the company’s gross margin will continue to remain under pressure.

Best Buy is working on margin enhancement and cost reduction initiatives to offset the margin impact arising from its price matching policy. It aims to reduce its cost of goods sold by increasing its supply chain efficiency through freight consolidation and vendor rationalization, which helps lower shipping costs and increases purchasing power. Best Buy has also changed the space allocation in a number of its stores to enhance revenue and profit per square foot, by allocating more space to higher margin products.

Considering that Amazon operates under a much lighter cost structure, it will always have enough room to maneuver pricing  and reclaim lost market share. Business strategy experts are of the opinion that price competition is not a solution to competing with a business such as Amazon, which has an inherent low cost advantage. Investors seemed to believe that Best Buy’s ‘Renew Blue’ strategy would bring about a turnaround in the company’s fortunes, evident from the persistent upward momentum in its stock price in 2014. But, some caution from the management about challenging times ahead has put some brakes on the stock price’s upward momentum.

At the start of 2013, Best Buy outlined six key initiatives under the “Renew Blue” program to turn around the company:

1. Accelerating online growth
2. Enhancing the multi-channel customer experience
3. Increasing revenue and gross profit per square foot to enhance store space optimization and merchandising
4. Driving down cost of goods sold through supply chain efficiencies
5. Continuing to gradually optimize the U.S. real estate portfolio
6. 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 in fiscal 2015 as well.

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1. Holiday retail sales growth was better than expected, LA Times, January 8, 2015 [↩]