Are Best Buy's Earnings a Warning?

Eek - I don't like this report....

Same-store sales down 3.9% isn't good, but what's worse is the SG&A numbers rising from 20.8% to 21.8%.

That's overhead - and this is exactly what I was expecting to start seeing. There's only so much "fat" you can trim from companies, and at that point you have big trouble because there are fixed costs that are difficult or impossible to drop in line with decreasing sales.

What I like even less in this report is that revenues were up (topline) y/o/y but net earnings were down big, about 20%. Topline is up as a consequence of new stores and Europe being added, but its not flowing through to the bottom line. That smacks of a nasty shift in the items being purchased, and is in line with what I have observed at the store around here - people are buying what they need, but "need" is being defined down. A netbook instead of a full-fledged notebook computer, for example, which whacks on margins in a bad way.

With this coming in the "back to school" quarter it is a screaming warning on the upcoming holiday season; this is the first of the big retail chains to report actual earnings (as opposed to just "sales" numbers on a weekly or rolling basis) and if this sort of shift continues to show up in other retailers there is going to be a lot of pain to come in the third and fourth quarters.

Finally, remember that Best Buy (BBY) has tremendously benefited from Circuit City's demise; the removal of what had been a major competitor never hurts your results. That they were unable to capitalize on this says that most of that business appears to have gone elsewhere - perhaps to WalMart? Or worse, it just disappeared!

The company increased guidance but what I see here is a sales trend shift on ticket size and profitability that is likely to continue in the wrong direction going into the Holiday Season. Should that occur the potential for a monstrous miss in the holiday quarter goes up dramatically. The PUTs are expensive comparatively and I believe upside price action is capped around the 08 level in the mid 40s; should we get a move up into the $45 level that looks like a gift from God as a short entry, and I have every intention of taking it.

Disclosure: No current position but tracking for a short entry.

Comments

[lynnybee:]

...."business appears to have gone elsewhere - or, worse, it just disappeared!" .....that's what happens with so many of our young people deep in debt on credit cards ! In my day we weren't even allowed credit cards until you were well-established. Banks targeted our young people as a source of never-ending interest payments & fees. BEST BUY is one of those stores that just irritated the heck out of me .........selling worthless stuff that drainied the wallets of our young people AND put them in debt with the credit cards.

Sep 15 10:08 AM

[Karl Liesman:]

Karl says, "What I like even less in this report is that revenues were up (topline) y/o/y but net earnings were down big, about 20%."

Where do you get the 20%? I'll assume that it's from the quarterly decrease in Operating Income of 339 in '08 vs. 280 in '09? But what about the six months ending the periods which only shows a decrease of about 6.5% (616 vs. 576) further down the report? Obviously, you missed the crash that occurred between August of 08 and August of 09?

The fact is that if you actually read the whole report you'll see that the Domestic Performance Summary shows AN IMPROVEMENT over 2008 while the numbers were dragged down by international performance.


Karl says, "That they were unable to capitalize on this says that most of that business appears to have gone elsewhere - perhaps to WalMart? Or worse, it just disappeared!"

Report says, "The company said it believes its domestic segment gained strong market share and that these gains accelerated in the quarter, growing approximately 270 basis points for the three months ending July 31, 2009 as compared to the prior year period."

What don't you get about increased market share Karl?

Sep 15 11:30 AM

[ebworthen:]

I heard comments similar to Karl's on CNBC this morning so...

Sep 15 12:26 PM

[Karl Liesman:]

Horvers, real JP Morgan analyst called gross margins a 'disappointment' but comp sales 'bullish' and a 'positive' on CNBC. OTOH, Karl calls it 'not good' in this article. The analyst has real financial experience and Karl does not.

Analyst has target at $43 to probably be rolled into 2010 but acknowledges that BBY may lose share going forward.

www.cnbc.com/id/158402...

Sep 15 12:44 PM

[Dialectical...:]

On Sep 15 11:30 AM Karl Liesman wrote:

>
> What don't you get about increased market share Karl?

Maybe the part where that leads to same store sales down 3.9%... Good thing their market share didn't increase any further or they'd really be in trouble!

Sep 15 01:18 PM

[Karl Liesman:]

So why did a real JPM analyst call sales 'bullish' and a 'positive' on CNBC this morning? Do you have the competitors numbers because maybe he's saying BBY is pulling ahead. It isn't hard to see that with CC out of the picture BBY got a huge boost. Their domestic performance shows it clearly, can't ignore that.


On Sep 15 01:18 PM Dialectical Materialist wrote:

>
> On Sep 15 11:30 AM Karl Liesman wrote:

Sep 15 01:47 PM

[dingojoe:]

A 3.9% SSS decline is pretty impressive for any retailer that doesn't sell groceries right now.

Circuit City was down to 2B in sales per quarter last year(BBY did 11B), so much of the business had already been plucked.

Sep 15 03:25 PM

[Dialectical...:]

It certainly can't hurt to have fewer competitors, so I agree that is good news. But even with that boost, they are still seeing same store sales declines. DingoJoe suggests that "only" 3.9% is something positive. Maybe it is. Maybe BBY is doing better than its competition. This could be long term bullish for the stock and good for the company. But I agree with the author's major point that this does not bode well for the holiday nor for the profit margin of what they must be selling. I think this suggests some major challenges in the coming quarters. I don't dislike BBY -- there are certainly higher priced stocks out there -- but I don't think they will be seeing real growth for some time now. I probably wouldn't sell if I had it, but I'm not buying under these circumstances. Maybe by spring we will get a better picture of where the consumer is, but this Christmas he'll be huddling at home making the holiday more about "quality time" and less about gifts I suspect.


On Sep 15 01:47 PM Karl Liesman wrote:

>
> So why did a real JPM analyst call sales 'bullish' and a 'positive'
> on CNBC this morning? Do you have the competitors numbers because
> maybe he's saying BBY is pulling ahead. It isn't hard to see that
> with CC out of the picture BBY got a huge boost. Their domestic
> performance shows it clearly, can't ignore that.

Sep 15 03:50 PM

[Liz:]

It's not terribly difficult to get off the floor.


On Sep 15 11:30 AM Karl Liesman wrote:


>
> The fact is that if you actually read the whole report you'll see
> that the Domestic Performance Summary shows AN IMPROVEMENT over 2008
> while the numbers were dragged down by international performance.
>

Sep 15 07:04 PM

[Donald Ingram:]

Christmas will be lean this year. Plain and simple. Like it used to be.
Celebrations will be centered around family and friends, ensuring each one is doing as best as possible in the circumstances.
For the retail sector to expect the consumerism of past years to return is to also believe in Scanty Claus! There isn't one and it ain't gonna happen. Sorry to be a bah humbug this early, but you gotta face facts! People are really hurting out there, and they're scared. When people are like this they tuck their heads in and bunker down.

Sep 16 01:42 AM

[genghis khan:]

The principal reason that stores like Circuit City, Best Buy and others are seeing declining sales is due largely to the major on-line retailers (Amazon, NewEgg, Directron, et.al.) taking share. They don't have the overhead that bricks and mortar stores have, and can offer better discount prices across the board. Plus, they frequently don't collect state sales tax in some states. This plus free shipping adds up to greater savings for the burgeoning numbers of cost-consious shoppers in these tighter times. The squeeze on peoples wallets has greatly dimished whim, spur-of-the moment purchases, yielding to delayed gratification. Electronics and other hard goods do not have size issues like clothing, and shoppers can do their due-diligence re. features on-line as well. Just wait for Big Brown to ring the doorbell a few days later. Times change, so do peoples habits.

Sep 16 03:07 AM

[Wayne Freeman:]

I agree with genghis' theory. I shop online alot, and the large retailers have powerful databases which store all the consumers page hits, and use that information to refine and present more relevant information on the user's current page on-screen. This data is saved and reviewed upon a return visit by the consumer. This approach is more timely and useful than anything a walk-in store can offer.

Like G_K says, times change and walk-in retailers are going to suffer.

Sep 16 03:21 AM

[Homer II:]

I recently purchased a large flat-screen TV from Amazon. It was $85 cheaper than the lowest price in my city which has BB, CC, and several other outlets. Shipping was free and included a service man contracted locally by Amazon who delivered and installed it, checked for damage or defects before leaving. Beautiful! Couldn't be any easier. I never left the house to look at the stores. The pesky sales types make appliance shopping a dread.

Sep 16 03:32 AM

[proxyjoe:]

BestBuy. Their staff is all arrogant high-school dropouts. They have this PC repair bunch called "Geek Squad" who aren't competant in either diagnosis nor repair; just trained in selling something to a dummy that they do not need. They have a website but it is aggravating to try and use. Poorly organized, badly indexed, and is sloowww.

Cercuit City was even worse. I could see how they folded up.

I don't think that looking at financial reports all day can tell you as much about a retail store or website as actually visiting some and noting how well-run the place is, how organized, how attentive and knowledgeable they are, and price checks for comparisons is the key.

Sep 16 03:49 AM

[ebworthen:]

I agree with Mr. Denniger, not the other Karl.

I also agree with genghis kahn's comment that brick and mortar stores are losing business to online retailers.

Why would I walk into Best Buy, be assaulted by pugnacious kids, and pay state sales taxes? No thanks. I'll order online, avoid the taxes, and get free shipping thank you very much (that is, if I spend any money).

There was caution from several commenter's yesterday on CNBC about this being a positive number; and that is unusual.

Sep 16 02:23 PM

[Rwong8200:]

BB has a great deal going against them the balance of the year.
Average retail price of all CE laptops, LED Tv, game consoles, navigation all falling by 15 to 20%. Digital deadline in June pulled forward millions of TV purchases. Cell Phone competition tougher and those prices are falling also. Last year $600 stimulus checks a Huge percentage were spent on CE. One year from now they should blow away comps. We are not seeing the usual nesting boom we have seen in past recessions. Finally BB has big presence in states hardest hit by the recession. Finally Amazon and internet have taken business on smaller shippable products. I sold BB position in August.

Sep 16 03:08 PM

[billddrummer:]

On Sep 16 03:08 PM Rwong8200 wrote:

> BB has a great deal going against them the balance of the year.<br/>Average
> retail price of all CE laptops, LED Tv, game consoles, navigation
> all falling by 15 to 20%. Digital deadline in June pulled forward
> millions of TV purchases. Cell Phone competition tougher and those
> prices are falling also. Last year $600 stimulus checks a Huge percentage
> were spent on CE. One year from now they should blow away comps.
> We are not seeing the usual nesting boom we have seen in past recessions.
> Finally BB has big presence in states hardest hit by the recession.
> Finally Amazon and internet have taken business on smaller shippable
> products. I sold BB position in August.

Looks like you left money on the table.

Apart from that, good analysis.

Some rejoinders:

BBY is still best in class for CE retailing, with a broad product mix and knowledgeable salespeople.

The GPM has stabilized this quarter, and I expect it to rise as services revenue becomes a larger portion of total sales.

SG & A expense margin increase resulted from a higher cost business model for Best Buy Europe. SG & A expense in the US was flat, despite the comp-sales declines.

Leverage is low, and 16X forward earnings seems a reasonable entry target.

Efficiency is improving, as shown by lower inventory carry despite a higher store count.

Disclosure: Long BBY in its ESPP.

Sep 16 03:39 PM

[TeresaE:]

Serves the b*stards right.

Two (or three, I lose count in the fun) years ago Best Buy decided their sales staff was making too much money. The best paid store employees were making between $11 & $12 an hour, no benefits of course. Not rich, but at least it was a livable wage for a kid.

So, in a "cost cutting" effort they arbitrarily slashed the wages to around $8 an hour. The CEO took a multimillion dollar bonus for his "job well done." I have not spent one red cent in their stores since that happened. I'm sure their own employees aren't spending much either. Would love to see what their shrinkage rate did after that brilliant move.

Anyway, as an investor, you should be scared out of your minds with this company. They slaughtered their payroll, eliminated TWO major competitors (and thousands of little ones) and they are still sliding downhill fast. Wait until forced healthcare, unionism and increased utilities hit 'em.

Sadly it makes my Evil Streak happy and it serves them right. They, and nearly every other major company in this country, continuously create MORE customers that are broke, struggling and unable to pay for the things they already have.

Then investors are actually shocked that the company is disintigrating beneath your feet? Better get used to it as most American companies are crumbling and they continue to fire your customers to try and "survive."

Sep 16 07:53 PM