Best Buy's Earnings Continue To Improve On Turnaround Strategy

| About: Best Buy (BBY)

Electronics retailing giant Best Buy (NYSE:BBY) posted revenue of $9.36 billion in Q3 fiscal 2014, which was flat as compared to the prior year. (Fiscal years end with January.) While domestic revenue showed annual growth with an increase in comparable store sales, it was offset by a decline in the international business. Additionally, the company saw non-GAAP diluted EPS of $0.18 in Q3, which was better than expected, as it continued to record cost savings through the Renew Blue program.

Best Buy's gross margin fell by 60 basis points annually to 23.2%. Domestic gross margin was hurt by factors such as higher warranty expenses in the mobile phone category, increased investments in price competitiveness and unfavorable product mix. The international gross profit dipped due to challenges in the Canadian business. However, SG&A expenses as a percent of revenue decreased to 21.9% as compared to 23.4% in Q3 fiscal 2013. This was attributed to cost savings through the Renew Blue program, better expense management and reduction in labor-associated costs at stores. This led to annual expansion of 100 basis points in operating margin to 1.0% in Q3 fiscal 2014.

With the promotional activity expected to intensify in the electronics market during the fourth quarter, Best Buy aims to match the pricing strategies being adopted by its competitors. This is expected to negatively impact gross margin during the fourth quarter.

Snapshot Of Q3 2014 Results

Domestic revenue rose by 2.3% annually during the quarter as a result of 1.7% growth in comparable store sales. We are encouraged by the improvement in this metric as it indicates that Best Buy's strategies are yielding positive results. Excluding the negative impact due to certain short-term measures, the comparable stores sales increased by 2% annually.

Domestic comparable online sales rose by 15.1%, as compared to 10.5% growth in the previous quarter, owing to factors including higher traffic, growth in average order value and increased inventory at the online channel. We believe this metric will continue to post strong growth in the future, as Best Buy is taking several measures to enhance its e-commerce channel.

The international revenue fell by 11.3% on account of factors such as a 6.4% decrease in comparable store sales, store closures in China and Canada, and adverse currency effects. Weak industry demand in Canada and the expiration of government subsidies in China contributed to the significant drop in comparable stores sales in these markets.

Progress Was Seen On The Renew Blue Program

At the beginning of this year, Best Buy initiated six key initiatives under the "Renew Blue" program to turn around the company. These include: 1) accelerating online growth; 2) enhancing the multi-channel customer experience; 3) increasing revenue and gross profit per square foot to enhance store space optimization and merchandising; 4) driving down cost of goods sold through increased supply chain efficiencies; 5) continuing to gradually optimize the U.S. real estate portfolio; and, 6) further reducing SG&A expense as a percent of sales. The company made progress against each of these strategic initiatives during the quarter and will continue to invest in them going forward.

During the quarter, Best Buy optimized its e-commerce channel by making improvements to site navigation and by adding loyalty features and product reviews to its website. The company will continue to enhance this channel during the fourth quarter, with features such as product buying guides, additional product information and an expanded online product portfolio. The Net Promoter Score (NPS) which measures satisfaction levels for both customers that buy and don't buy products rose by 400 basis points annually. (Best Buy Management Discusses Q3 2014 Results - Earnings Call Transcript, Seeking Alpha, November 19, 2013)

Optimization of floor space was undertaken by devoting more space to profitable product categories such as mobile phones and tablets. The company also launched 500 Windows stores, and realigned space for new gaming product launches. In addition, the company realized $115 million in cost savings through reductions in cost of goods sold and SG&A expense. This resulted in total annualized costs savings of $505 million, which brings the company closer to its total target of $725 million. [1]

We are in the process of revising our price estimate for the company's stock.

Disclosure: No positions.