Best Buy - Cost Control Outweighs Continued Sales Decline As Long-Term Prospects Remain Doubtful

May.26.14 | About: Best Buy (BBY)


Best Buy again posts a drop in sales amidst harsh weather and a very competitive electronics retail environment.

Yet cost savings sort effect, thereby boosting earnings.

Long-term competitive position remains a worry.

Best Buy (NYSE:BBY) released a set of first-quarter results this week which reveals that the company is not out of trouble yet.

A ¨lack of innovation¨ within the electronics industry resulted in a tough environment as middle class consumers see continued pressure on their discretionary income. Higher fuel prices and a pick up in food inflation is hurting the US middle class.

Poor weather at the start of the year has impacted store traffic as well.

First Quarter Headlines

Best Buy reported first-quarter revenues of $9.03 billion, down 3.3% compared to last year.

The company posted GAAP earnings of $461 million which compares to an $81 million loss last year. Earnings were inflated thanks to an income tax benefit related to the reorganization in Europe. Non-GAAP earnings rose by a penny compared to last year, coming in at $0.33 per share.

Looking Into The Results

Best Buy's revenues were largely under pressure as a result of falling comparable store sales which overall were down by 1.9%.

Domestic comparable sales were down by 1.3%, while online sales improved by 29.2% to $639 million. Combined, sales in the US fell by 2.1% to $7.78 billion. The company suffered from a consumer electronics business which continues to shrink even as the company gained market share.

Gross margins fell by 70 basis points to 22.7% of sales due to less favorable economics from the new credit card agreement which shaved off 60 basis points of margins. Increased mobile warranty costs and pricing initiatives explained the remainder of the pressure on margins.

The company managed to reduce selling, general and administrative expenses by 90 basis points to 19.7% of sales. Continued Renew Blue cost initiatives and tight expense management were the reason behind cost reduction.

International comparable store sales which fell by 5.8% were rather weak. Overall, international sales fell by 10.5% to $1.25 billion due to store closures in China as well as adverse currency movements.

Gross margins were down by 80 basis points to 20.5% of sales while selling, general and administrative expenses came in at 22.7%, creating sizable losses. Best Buy did manage to cut international selling, general and administrative expenses by 210 basis points compared to last year.

Valuing The Business

Best Buy ended the quarter with little over $3 billion in cash, equivalents and short-term investments providing the company with sufficient liquidity. Total debt stands at $1.65 billion, resulting in a comfortable net cash position.

At $27 per share, Best Buy commences a valuation of $9.4 billion, which values operating assets at around $8 billion given the net cash balances held by Best Buy. This values operating assets at roughly 0.2 times annual revenues and roughly 15 times reported earnings over the past year.

The quarterly dividend of $0.17 per share provides investors with an annual dividend yield of 2.5%.

The Outlook For The Rest Of The Year

For the second and third quarter, Best Buy continues to anticipate sales declines in key consumer electronics categories. Softness is furthermore seen in mobile phones with consumers waiting for new product launches.

As a result, comparable sales are expected to fall in the low single digits in the next two quarters. Best Buy furthermore anticipates continued pressure on prices and costs related to Renew Blue investments. These pressures are expected to be offset by continued cost reductions.

Takeaway For Shareholders

The earnings release was a mixed bag. On the one hand, revenues fell short of estimates and were down again. Revenues have been down for 9 straight quarters in a row now.

On the bright side, Best Buy managed to grow earnings as cost savings offset margin compression with non-GAAP earnings coming in comfortably ahead of consensus estimates at $0.19 per share.

That being said, Best Buy warns for continued pressure on sales in the coming two quarters while the company is hopeful that anticipated innovations in the holiday quarter can boost sales.

The combination of severe gross margin pressure and falling sales has been a dangerous cocktail, yet CEO Joly has been very aggressive in cutting costs. The new cost reduction target calls for a billion in annual expenses being taken out at the current run rate.

I remain in doubt about Best Buy's future. The company is making a turnaround, has sufficient liquidity and operates with a strong balance sheet. Yet prospects for real growth are not very good as the company is struggling to even maintain revenues. Given the very competitive retail environment and the continued growth of online competitors, growing future revenues will be a huge task.

I remain on the sidelines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.