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Best Buy and Macy's really aren't so different

At first blush, Best Buy doesn't have much in common with the major department store players.

While the Macy's and Nordstroms of the world rely on mall traffic to generate the majority of their sales, Best Buy's footprint skews toward open-air shopping centers and stand-alone shops.

The product mix at these retailers is also decidedly different. Whereas department stores generate the lion's share of their sales from apparel and handbags, Best Buy leans on consumer electronics.

Yet the same issues that have plagued department stores this year are similarly weighing on Best Buy's results and growth prospects: A lack of innovation and price deflation in its bread-and-butter categories.

A shopper browses prepaid phone merchandise at a Best Buy store in San Francisco.
David Paul Morris | Bloomberg | Getty Images
A shopper browses prepaid phone merchandise at a Best Buy store in San Francisco.

In the face of a quiet quarter for mobile phone launches, comparable sales in Best Buy's domestic computing and mobile phone segment declined 3.5 percent during the first quarter. Though that drop is an improvement from the fourth quarter's 6.8 percent slide, it's more pronounced than the dip from the prior-year period. These categories are crucial for Best Buy's sales growth, as they account for roughly half its U.S. revenue.

Meanwhile, the electronics chain pinned its hopes for revenue growth on back half of the year, when new products (read: the iPhone 7) are expected to go on sale.

This broad-based slowdown in spending on mobile phones and tablets contributed to the 8 percent dip in Best Buy's shares Tuesday, as blockbuster online sales growth, a beat on both the top and bottom lines, and unchanged full-year guidance weren't enough to convince shareholders to stick around.

Adding pressure to the chain's shares, Best Buy announced the departure of its "rock star" CFO Sharon McCollam, who had been critical to the brand's turnaround.

"We can't imagine seeing U.S. comps [improve] meaningfully for the foreseeable future," Citi analyst Kate McShane told investors after the company's report. "4K TV sales have sold well but haven't been enough of a game changer to offset weakness in other areas like phones, tablets, PCs and video games, and the next generation of iPhones may not be significant enough to materially move the needle."

McShane added that virtual reality is a story for 2017 at the earliest, if the technology gains traction at all. Because of these broader trends and McCollam's pending departure, McShane downgraded Best Buy shares to "neutral" from "buy."

On a call with analysts Tuesday morning, Best Buy CEO Hubert Joly said price deflation has had a material impact on the chain's results. Price reductions are an ever-present threat in the electronics category, as constant innovation causes products to become cheaper and more mainstream. Joly cited a 30 percent decline in the average selling price of 4K TVs during the quarter, according NPD data, as an example.

"Best Buy tends to do particularly well in the first part of any product cycle," he said.

Yet Joly said the company will continue to do everything in its power to grow sales amid softer consumer demand. In the most recent quarter, investments in Best Buy's website and an increase in the number of packages arriving in two days or less contributed to the company's 24 percent digital sales gain during the quarter.

Best Buy again increased its market share during the quarter, as its comparable sales came in roughly flat. That compares to a 1.9 percent drop in NPD-tracked categories, which include TVs, computers and tablets (excluding the Kindle). They do not include mobile phones or appliances.

Conlumino, a retail research firm, estimates that total U.S. electronics sales fell 0.4 percent during the quarter.

"While the first quarter is generally a less important one for Best Buy — representing only around 15 percent of annual revenues — these results show some signs of progress following the very disappointing final quarter," Conlumino CEO Neil Saunders told investors.

Analysts were shaken by McCollam's upcoming departure, which was a key driver behind the stock's move lower. By Joly's side, the CFO has already helped the company save $1 billion annually, with another round of $400 million in cuts underway.

McCollam has groomed successor Corie Barry for the role, and will stay with the company as an advisor until 2017. BB&T analyst Anthony Chukumba called the outgoing CFO a "rock star," and "one of the most talented retail executives in the U.S. today."

After news of her departure, Chukumba lowered his price target on Best Buy to $36 from $40, citing "incremental risk" to the brand's long-term strategy.