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Summary

  • Best Buy’s competitors will test the company's ability to survive.
  • Declining sales in key consumer electronic areas are keeping revenue growth in a negative direction.
  • Best Buy’s has few options to increase profit margins.

Back in January of this year, Best Buy (NYSE:BBY) plummeted some 33% following reports of disappointing holiday sales. It was the largest single-day percentage drop for the stock since August 8, 2002. By the end of the trading on January 16, 2014 shares were down 28.59%, or $10.74 per share, to close at $26.83. Increased competition, key consumer sales declines, and pressured margins were all primary factors contributing to the disappointing holiday season and outlook. A closer look at BestBuy today reveals little has changed.

Competition

Online retailers such as Amazon (NASDAQ:AMZN), mass merchants, warehouse clubs, and even original equipment manufacturers continue to splinter market share for Best Buy. Unfortunately, Best Buy has little defense against declining market share due to competition. Amazon continues to aggressively take potential Best Buy sales through its Kindle tablets and even readers, as well as, it's Amazon prime service. In short, Best Buy is battling a competitor in Amazon that has a structural cost advantage, higher customer satisfaction and a green light from its investors to operate at razor thin margins. It's hard enough to face a competitor like Amazon. Best Buy also has to worry about giants like Walmart (NYSE:WMT). Competition was a primary driver in the steep decline Best Buy experienced earlier this year. Unfortunately, the competition has only escalated.

Key Product Sales Are Currently In Decline

NPD report shows software industry sales fell 25% in May. Software sales were also the lowest since May 2000. Why is this important to Best Buy? Because part of Best Buy's turnaround (or at least one of their attempts at participating in a higher margin environment) is under attack from GameStop (NYSE:GME). The transition in console generation products continues to restrain content in the video game market which ultimately limits increasing sales (at least for the short term). In addition, a consumer showing signs of withdrawal from a fragile economy will also contribute to sales declines. Finally, it is no secret the physical music and video business is dying, and Best Buy is wasting valuable time and money on this business. In nearly every large Best Buy store there is a large amount of square footage devoted to physical music and DVD sales. This transition will not only incur significant expenses, but will need to be effectively replaced.

Negative Outlook for Profitability

With competition heating up and certain sales declining, profitability becomes elusive. Maintaining market share requires price competitiveness. Lower prices mean lower margins. Although Best Buy's profit margins increased in the latest quarter, cost cutting was the primary driver behind the modest rise. Cost reductions are wonderful until you reach a point of diminishing returns. Eventually, survival depends on increasing sales. However, Best Buy expects same-store sales to fall in the current quarter and the next on lower demand for many consumer electronics, and especially for mobile phones as shoppers were waiting to buy new models, the company said.

Given the headwinds of increasing competition declining sales and margin pressures, Best Buy shares should ultimately move lower (and perhaps much lower).

Source: Best Buy's Decline Not Complete