Best Buy: An Industry Leader on Top of the Electronics Game

Dec.13.06 | About: Best Buy (BBY)

Best Buy (NYSE:BBY) is the leading U.S. retailer of consumer electronics. It also sells home-office products, entertainment software, and appliances. The company reported disappointing third quarter earnings yesterday, and that news knocked $3 off the stock price, but management remained upbeat about the future, including the all-important holiday season. The question for investors: will aggressive price competition finally suck the life out of Best Buy's profits, or can this retailing champion find a way to bring home the prize once again?

Best Buy operates over 1,000 retail locations throughout the U.S. and Canada, and it has a small but growing presence in China. Best Buy's stock is blown by the winds of consumer spending, and when we looked at this stock a year ago there was a distinct headwind blowing. Since then, strong consumer spending particularly on electronics such as flat-screen TVs has helped the company to deliver outstanding earnings, until today. The worry now is that even if this holiday shopping season is strong, competitors like Wal-Mart (NYSE:WMT) are slashing prices and that may put a permanent pinch on margins for Best Buy.

Third quarter numbers for Best Buy were hurt by a "very competitive climate" according to the company press release, so earnings per share of 31 cents came in 4 cents below the consensus. Net income was still up 9% and other aspects of the quarter were not too shabby, including a 4.8% increase in same-store sales and overall revenue growth of 16%. Moreover, management said it is gaining market share and margins are expected to rebound a bit in the fourth quarter of its fiscal year ending in February. The company reiterated guidance for the year of $2.65-$2.8
0, same store sales growth of 4%-5%, and revenue growth of 16% which puts it on track for approximately $35.8 billion in sales.

Longer-term, the economic expansion seemed to stumble a bit in late 2005 but then revive, and now it's on a more comfortable trajectory that should support healthy consumer spending. Spending remains solid particularly on nesting items like flat-screen TVs and home theater systems. That provides a favorable backdrop for Best Buy's future. Sales are expected to top $39 billion in the next fiscal year, and analysts are forecasting an average annual growth rate of 16% for earnings.

Best Buy seems to ride one trend after another to big profits, whether its computers and home entertainment systems to DVD and video game software. That's not luck, and Best Buy is not resting its future on the flat-screen boom now. The company employs a strategy of "customer centricity" to make sure that it is always catering to the select customers that matter the most. The company says that about 20% of its customers account for 100% of its profit.

New store openings [about 75 new stores per year] are also a big part of the growth picture. The company is in the early stages of expansion into China. It is opening "lab stores" in China to study Chinese buying patterns in advance of larger expansions there.

The company also sees plenty of opportunity for growth in North America, with plans to add about 320 stores over the next few years for a total of roughly 1,200 stores. Currently most Best Buy stores are in suburbs, but the company has worked to reduce building costs and increase new store profitability so that the stores can be opened in smaller markets, cities, and in between larger suburban stores.

Retail stocks tend to run hot and cold with investors and the retail environment can be fickle, yet Best Buy has proven over the years that it knows how to stay on top of the electronics game. The stock is certainly not a bargain-hunters dream even after today's dip, but for investors who like an industry leader and for those who think consumer spending is on solid ground, Best Buy may be worthy of further investigation.

BBY 1-yr chart

Disclosure: Author has no position in BBY