Is a Divergence in Retail Sales and Property Prices an Indicator of Risk for Best Buy?

Best Buy (NYSE:BBY) is a specialty electronics retailer that competes with general retailers like Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST) as well as other specialty retailers like GameStop (NYSE:GME) and Radio Shack (NYSE:RSH). Our price estimate for Best Buy stands at $38.48, which is about 11% above the current market price.

According to a recently published article on DailyFinance, the retail sales and retail property prices in the U.S. seem to be diverging as evident from the calculated index for property prices vs. adjusted retail & food services sales (in $ billion). The index used for retail property prices is Moody’s/REAL National Retail Property Price Index. The chart below is taken from the same article and shows this unusual divergence. ^[1]

What does this indicate? Prices are a function of supply and demand and when either supply becomes surplus or the demand goes down, prices tend to dip. So one could conclude that despite improvements in retail sales, the demand for retail property space has not picked up. The big retail chains and local stores occupy the retail space, and thus either low demand or excess supply could point to a difficult environment for Best Buy.

Shift to Online Retailing – Best Buy Loses Edge

Clearly online retailing requires a lot less retail property space compared to traditional brick-and-mortar format employed by big retail chains like Wal-Mart, Best Buy, Target and Costco. We agree that the rise in retail sales despite dip in retail property prices could indicate that more sales are shifting online now, which is a clear trend.

However the article also states that:

We believe that this conclusion holds special significance for Best Buy. Although we acknowledge that the company has been pushing significantly into online sales itself and its online sales are growing at a much faster pace than its overall sales, a shift to online shopping is likely to detract from a distinguishing feature of Best Buy in customer service.

We wrote an article discussing this aspect (see article Is Best Buy Losing its Edge?). Best Buy’s differentiating factor is its customer service and product expertise from salespeople. Customers often choose Best Buy over discount retailers with the expectation of receiving help in making more informed decisions regarding products featuring cutting-edge technology. However a greater shift to online retailing could pose danger to Best Buy’s differentiating factor.

Multi-Purpose Retailers – Best Buy competes more

While not specific just to Best Buy, one of the possibilities not mentioned in the article could be retailers trying to sell everything – or “channel blurring.”

Some of the examples are that Wal-Mart is pushing more into electronics, and chains like CVS and Walgreens are stocking more groceries. Retailers are trying to optimize current space to let consumers buy more (both in type and amount) goods from their stores and increase traffic. For example a consumer who might buy groceries at Wal-Mart and electronics at Best Buy may be tempted to buy both at Wal-Mart.

What does this behavior imply?

More utilization of current space thereby reducing the need of additional retail spaces. If Wal-Mart makes its consumer electronics offering attractive, it could prove as a disincentive for retailers like Best Buy to open a store in same region. We do not have evidence as to whether this has impacted demand for retail space materially in the past, but it is something not to be ignored and could be an important issue to tackle for retailers in the future.

At the end of it, the risks to Best Buy boil down in terms of risks to its store expansion as well as revenue per square foot. You can see how these drivers impact its price estimate by scrolling through the slideshow above.

You can see the complete $38.48 Trefis price estimate for Best Buy’s stock here.

1. Low Retail Property Prices May Mean Trouble for Big Chains, Daily Finance, Jan 26 2011 [↩]