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Best Buy Margins ‘In a Downward Spiral’: Analyst

Tuesday, 21 Aug 2012 | 1:16 PM ET
AP

Don’t bet on growth inBest Buy’s margins anytime soon, says one analyst who told CNBC that he does see not see many ways for the company to turn itself around.

“I just think we’re in a downward spiral in terms of margins right now,” said R.J. Hottovy, an analyst at Morningstar. “We don’t really see any way for this company to get on a positive margin expansion trend going forward.”

Best Buy , which just named a new CEO on Monday, is in the midst of a transition as it battles structural issues in the consumer electronics retail industry as well as internal issues, Hottovy said.

“What we’ve always found in the consumer electronics industry — no matter what level of service the company provides, the consumers always flock to the lowest cost provider, and right now Best Buy just can’t compete as it’s currently structured with the Amazons of the world,” he said.

Best Buy Can't Compete With Amazons of World: Analyst
R.J. Hottovy, analyst at Morningstar, has a neutral rating on Best Buy in the short-term, but a more pessimistic view in the long-term. "I really don't see a lot of ways for this company to turnaround," he says. "Best Buy -- where it stands now -- can't compete with the Amazons of the world."

Bradley Thomas, KeyBanc Capital Markets analyst, characterized Best Buy as a company that is stuck in the middle. Thomas has a ‘hold’ rating on the stock.

"They don’t have service that’s good enough to really differentiate them, and we question whether consumers would really be willing to pay for good service, and on the pricing side, we know they’re being undercut by Amazon ,” Thomas said.

During the quarter, the company’s missed both earnings and revenue estimates, sending its shares sharply lower on Tuesday. It also reported a 3.2 percent reduction in same-store sales. The drop was the eighth decline in the last nine quarters.

One of the company’s top priorities is fighting “showrooming,” a common phenomenon in which consumers visit Best Buy’s retail locations to test out products only to buy them online instead at discounted prices.

Hottovy added that vendors, such as Apple and Microsoft, are becoming less dependent on Best Buy as a distribution channel — a trend that he does not forecast changing.

Best Buy's Big Q2 Miss
Bradley Thomas, Keybanc Capital Markets, just got off Best Buy's conference call and offers his thoughts on the company and its new CEO.

Moving forward, Hottovy sees the closure of 30 to 40 percent of Best Buy’s retail stores as the best case scenario. He added that these savings should then be reinvested to boost the company’s price competitiveness and to enhance both Best Buy’s online and in-store experience.

The company has said it plans to cuts its retail locations more than the closing of 50 of its 1,100 locations that it announced five months ago.

Although Richard Schulze, Best Buy’s founder and former chairman, said earlier this month that he was interested in buying the company for $24 to $26 a share by teaming with private equity partners, Hottovy thinks Schulze would have to resort to a hostile takeover if he is going to succeed.

At this point though, Hottovy doubts that Schulze will take the hostile route and added that he has not heard many stories about private-equity backers looking to back the Best Buy story.

Still, Thomas called Best Buy “extremely inexpensive” and everything investors would look for on paper in a value stock.

“This should look very attractive to private-equity investors, and we think it could be a takeout candidate still,” he said.

—By CNBC.com’s Katie Little; Follow Her on Twitter @katie_little.

Additional News: Best Buy Founder: ‘I Won’t Go Away’

Additional Views: Time to Bet Against Best Buy?

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Disclosures:

R.J. Hottovy does not own shares of Best Buy. KeyBanc Capital Markets has an investment banking conflict with the companies mentioned in this article.

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