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Best Buy Margins Hammered by Heavy Discounting: Analysts

Tuesday, 13 Dec 2011 | 3:47 PM ET

Best Buy's efforts to boost sales — particularly on Black Friday — by deep discounting took a heavy toll on gross profit margins, resulting in the retailer's missing quarterly earnings estimates, Brian Nagel, senior research analyst at Oppenheimer & Co., told CNBC Tuesday.

Earnings fell short of analyst estimates at 47 cents per share, on revenue of $12.1 billion. Excluding items, the company had been expected to report third-quarter earnings of 51 cents per share, on revenue of $12.14 billion.

Best Buy's shares skidded more than 10 percent following the report.

The world's largest electronics chain reported a sales increase of 0.3 percent at stores open at least 14 months. "Sales were good," Nagel said. "By some measures they were even better than expected, but they clearly came at a cost."

Best Buy Earnings Fall Short
The shortfall in the quarter occurred because of gross margins, says Brian Nagel, Oppenheimer & Co. senior equity research analyst, who says the promotional efforts by Best Buy to boost sales heavily weighed on the retailer's gross profit margins.

Alan Rifkin, retail hardlines analyst at Barclay's Capital, said that "given the intense competition in the consumer electronic environment, Best Buy will have to resort to continued promotions to drive revenues."

Still, Nagel said the company's strategic move to push for stronger sales, and its repeated attempts to gain market share through discounting may be hurting its bottom line.

"The question is, do we get better consumer mind share from this?" Nagel said. "In the near-term, it looks like a mistake to me."

Rifkin also cited Best Buy's plan to reduce its square footage by 10 percent over the next five years as part of the solution to the shortfall. "When you look at the growth of e-commerce, we'd like to see Best Buy take a more aggressive posture in pruning some of their real estate," he said.

Best Buy's Q3 Whiff
Despite promotional efforts, Best Buy shares are down this morning after the company missed Q3 revenue and earnings per share estimates. Perspective on where the company's prospects stand, with Alan Rifkin, Barclay's Capital retail hardlines analyst.

Barclay's maintained its neutral rating and kept its outlook on Best Buy unchanged, hovering 12 cents below Wall Street estimates. "We do see the prospects for Best Buy being brighter than [other electronics chains]," Rifkin said. "While there's no clear catalyst for the stock to move up, there is some valuation support in the low $20 range."

Nagel set a price target of $25 a share, calling it "basically fair value." He also gives Best Buy a lot of credit for being able to tough out the harsh competitive environment it continues to face.

"Over the past year or so, they've done a really good job of managing costs," he said. "They're generating a lot of cash and buying back stock, so they're controlling what they can."

Electronics retailers such as Best Buy and RadioShack are facing fierce competition from online rivals, most notably Amazon.com, and dealing with a very weak product cycle — one which would continue to be a challenge.

"There's just not really a whole lot of hot, new products to sell," the analyst said. "I don't see the LED or 3D [TV screens] driving substantial replacement demand anytime soon."

Nagel also called Apple products' impact on Best Buy stores a mixed bag.

"It's clearly a traffic driver for them, [but] I think it actually ends up hurting margins at Best Buy," he said. "Apple products tend to cannibalize potentially higher-margin products within their [own] stores."

Additional News: Best Buy's Quarterly Profit Squeezed by Discounts

Additional Views: Has Best Buy Become Amazon.com's Showroom?______________________________
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Disclosures:

Best Buy is an investment banking client of Barclay's Capital. Analysts Brian Nagel and Alan Rifkin do not personally own stock in the company.

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