Tickers in this Article: BBY, AMZN, MSFT, SNE
I know that the skeptics on Best Buy (NYSE:BBY) are going to look at Tuesday's results and ask “What recovery?” After all, comps are still declining and gross margins are still down on a year-over-year basis. What's more, the apparent erosion in high-end mobile demand is a sizable threat to a company that gets a lot of revenue from mobile devices. On the other hand, nobody should have believed that Rome would be rebuilt in a day, and Best Buy continues to deliver on multiple points of its recovery plan.

Some Bad, But Mostly Good In Q2
Best Buy reported another revenue decline for the quarter, as sales dropped less than 1% to $9.3 billion. This was still better than analysts expected, though, as with the comp-store decline of 0.6% (analysts were looking for a drop of 0.9%). Domestic comps declined 0.4%, while online sales grew more than 10% for the quarter. Within the comps, appliances were quite strong (up 14.2%), while the blended computing/mobile phones segment saw nearly 6% growth.

Margins were still mixed, but generally more positive than expected. Gross margin (adjusted, non-GAAP) dropped about a half-point from last year, but improved 60bp sequentially and surpassed the Street average estimate. Operating income was also stronger than expected, climbing 14% with a 30bp improvement in adjusted operating margin.

All told, Best Buy's continuing ops earnings were about 20 cents higher than the average Street estimate, or nearly two and a half times better than expected. I think it's also worth mentioning that inventory was down almost 7% compared to that sub-1% decline in revenue.

SEE: Earnings: Quality Means Everything

More Progress With Turnaround Initiatives
It doesn't look like there has been any backsliding with the company's Renew Blue turnaround plan. The store-within-a-store concept with Samsung seems to be performing well, and the company announced a similar deal with Microsoft (Nasdaq:MSFT) for a Windows store.

I'm still bullish on these mini-store concepts as a way for Best Buy to effectively shrink its store footprint, as it's not as though they can shrink the actual buildings, nor is it really cost-effective to relocate stores. I could see other electronics/consumer tech companies considering the concept in addition to Samsung and Microsoft – particularly if they prove to be effective in swinging share.

Efforts to drive better appliance and online sales also appear to be bearing fruit, though I'm a little disappointing that online sales growth was “only” 11%. While on the subject of online, I think it's also worth noting that Best Buy does seem to be seeing some traction from the pricing parity initiatives of major TV makers Samsung and Sony (NYSE:SNE), as the gaps with Amazon (Nasdaq:AMZN) have shrunk.

Still A Lot Left To Do
While some things are going well for Best Buy, there's still a lot of things that need to be fixed or improved. I'm not entirely sold on the company's foreign operations (comps down 1.8% this quarter), as I think it will be challenging to build a sustainable competitive business in China. I'm likewise concerned about the potential for slowing high-end mobile device sales to drag down comp sales performance in the coming quarters, as I'm not sure computing will improve enough to offset it.

SEE: A Look At Corporate Profit Margins

Last and by no means least, Best Buy's ultimate margin performance is still very uncertain. The company's cost-cutting efforts do seem to be progressing, but the company will need to prove that it doesn't have to reinvest all of that in gross margin (i.e. lowering prices) to hit sales/comps targets.

The Bottom Line
There are multiple examples out there of retail concepts that were supposedly dead men walking and yet managed to turn operations around (Home Depot (NYSE:HD) and Pier 1 (NYSE:PIR) immediately come to mind). True, neither faced the same sort of competition from Amazon that Best Buy does, but an improved online focus from Best Buy coupled with potential expansion of pricing parity programs and the collection of sales taxes from online retailers could further reduce Amazon's edge.

Best Buy shares have climbed almost 200% from the start of the year, and that tempts me to advise investors not to get too greedy. While Home Depot and Pier 1 turned around, Circuit City, The Wiz, and CompUSA all failed and there are still risks to Best Buy's plans and business model. Best Buy doesn't look particularly expensive on the assumption of mid-single digit future free cash flow growth, but expectations certainly appear to be ramping up as the turnaround progresses.

Disclosure – At the time of writing, the author did not own shares of any company mentioned in this article.

comments powered by Disqus

Trading Center