Best Buy: All Eyes On Margins As Management Plans Ahead

Jun.25.14 | About: Best Buy (BBY)

Summary

Company’s revenue base going through phase of recovery.

Competitive pricing policy will improve store traffic and support future revenue growth.

BBY needs more aggressive cost cutting efforts to support margins.

Best Buy (NYSE:BBY) is among the leading retailers in the U.S. and operates in a competitive industry. The company is striving to improve its operational performance through initiatives under its "Renew Blue Transformation" program, which is helping moderate sales decline. Moreover, the company is well on track to realizing cost savings, which are expected to fuel its earnings base. In addition, BBY's online business is also catering to the intense competition in the sector quite well. However, the company needs to clear the mess in its international segment and stabilize its gross margin.

Rescue of Long Compromised Revenue Base

The company's declining revenues in recent quarters have raised concerns among investors. The recent shift of customers towards retailers offering discounted and differentiated products has raised competition in the sector. The company has been aggressively cutting down prices to cater to the intense price competition. Over the quarters, these price cuts have been a drag on the company's revenue base; revenues were down 3.4% year-on-year in the first quarter of fiscal year 2015. The company's revenues have been decreasing since the last nine quarters, but the drop in revenues has been moderating in recent quarters, mainly as a result of BBY's competitive pricing policies. Also, efforts undertaken by the company to attract greater customer traffic through improved merchandising and marketing initiatives is helping the company moderate revenue decline in recent quarters, as shown below.
Click to enlarge
Source: Company's Quarterly Earnings Report

Moreover, I believe the company's revenue base will benefit in coming quarters from the company's plan of bringing in major merchandising transformation by rolling out 500 Samsung Entertainment and 350 Sony Experience stores-within-a-store. Furthermore, being the first and only national retailer to launch installment billing plans with multiple carriers, BBY will benefit from store traffic.

Earnings Growth = Praise the Cost Cut Initiatives

Under its 24-month Renew Blue program, the company has paid a lot of attention to its cost reduction. By the end of 1QFY15, the company successfully eliminated $95million of its annualized cost, which is helping it grow its earnings. Moreover, BBY's EPS was 65% ahead of analyst estimates in the recent quarter. Cost reductions efforts by the management have taken the total Renew Blue cost reductions to $860million, directing it towards the new target of $1billion. I believe with cost cuts and closure of underperforming stores, BBY will be able to grow its earnings base.

Online Business

With the recent shift in the shopping style of retail customers, the e-commerce business has increased the competitive heat among retail stocks. BBY's online business has been making progress to grow in this highly competitive industry. The recent quarter's 29% increase in domestic comparable online sales is highly attributed to the management's continuous efforts in leveraging ship-from-store, digital marketing and in enhancing the site's functionality. Moreover, for future improvements in online business, BBY's president and CEO recently said:

"We'll keep improving the shopping experience by implementing an improved homepage design, a more robust and streamlined wish list, significantly richer visual and editorial content, and enhanced search and navigation capabilities. We will also add returns to open-box inventory to the online assortment, enhance the online scheduling of home delivery and installation, and make it possible for customers to see their historical Geek Squad service plan purchases when they log into My Best Buy."

I believe BBY's promising online business future initiatives may pressurize the company's profitability for the near future, but will grow the online sales base at a decent pace.

Darker Sides = Act Fast

In the recent quarter, the company's international segment has been a mess, evident by a revenue drop of 5.8% year-on-year in 1QFY15. The major reason behind the revenue drop was negative currency impacts from Canada, China and Mexico. Moreover, the international segment's gross profit was also down to 20.5% in the recent quarter as compared to 21.3% last year. The management has ramped up its efforts to improve the results of its international segment by bringing strict expense management efforts in Canada and China.

The management is making efforts by cutting down SG&A expenses, which I believe are not enough, provided the recent quarter's SG&A accounted for 22.6% of its revenue. I believe the management needs to act fast to improve margins and support revenue growth, as a further drop in margins could prove deteriorating not only for the international segment's profitability, but also for the company's overall profitability.

Conclusion

The company's revenue base is going through a phase of recovery. The company's competitive pricing policy will improve store traffic and support revenue growth in the future. Moreover, the strenuous efforts of the management to grow its online business in this highly competitive environment will portend well to grow the top-line results of the company. Also, I believe the company needs more aggressive cost cutting efforts to support margins.

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