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Best Buy seems to be the best place for consumers to buy their gifts this holiday season. The company was forced to pursuit a high-discount, low-margin strategy heading into the Black Friday holiday season, giving great discounts to consumers.

Margin Compression

Shares are off already 18% year-to-date, before falling another 15% after the company issued its Q3 release. While sales were still up 2% totaling $12.1 billion, profits fell 29% to $154 million (excluding $137 million in restructuring costs). Facing stiff competition from online and discount retailers, Best Buy was forced to lower its prices. Gross margins came in at 24.2% vs. 25.1% last year, way under expectations as promotion expenses rose. Operating income came in at 2.7% vs. 3.2% last year.


The company issued its guidance for the whole year. It expects $51-52.5 billion in annual revenue, implying Q4 holiday season revenue to come in at $17-18.5 billion range (up from $16 billion last year). Comparable sales growth at best might be flat, at worst come in at -3%. While sales are on the rise, margins are being squeezed. Gross margin come in 50 bps lower on lower pricing while selling and general expenses are up 200 bps on higher promotional cost.

The $3.35-$3.65 full-year EPS range implies earnings per share of $2.00-$2.35 for the fourth quarter compared to $2.00 last year. Shares outstanding, however, reduced by some 10% over this period, suggesting net income for the most important quarter will be flat on 10% higher sales.

Value Play

Over the last year the company has returned a lot of cash to its shareholders. It spend roughly $1.2 billion in 2011 on share repurchases reducing outstanding number of shares by some 10%. On top of that, shareholders receive their annual dividend of $0.58, implying a 2.5% yield at this moment. After the recent sell-off the company trades at just 7 times its full-year 2012 earnings.

Value Trap

Don't get excited yet. Fierce discount and internet competition is hurting Best Buy's business. The forced move to aim for higher volumes, thereby depressing margins, is not paying off. While Best Buy seems an attractive value play at the moment, fundamentals could deteriorate rapidly if the company cannot get on a strategic sound track for the coming years. The "best buy" is not made by investors right now, it's done by consumers picking up some heavily discounted items at its stores.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.