Consumer electronics titan Best Buy (NYSE:BBY) reported first quarter earnings on Tuesday that came in well below analyst expectations. Management brushed off the shortfall as a short-term blip and stuck to its full year guidance. It also expects profits to improve at a steady pace over the longer haul, but a number of factors are currently working against these ambitions. (Learn to pick out your investments on your next trip to the mall in our related article Analyzing Retail Stocks.)

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First Quarter Sales and Profit Trends
Sales improved 6.9% to $10.8 billion on new store openings and positive comparable sales of 2.8%. Management cited strong, low double-digit comps in appliances, notebook computers and mobile phones to echo robust trends at underlying manufacturers such as Whirlpool (NYSE:WHR), Hewlett-Packard (NYSE:HPQ), and especially Apple (Nasdaq:AAPL). This offset weakness in music, movies and televisions, the last of which continues to see dramatic price decline and is worrying at it had been a major sales contributor to Best Buy.

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Looking at profitability, gross margins rose to 25.9% of sales, but was offset by a rise in SG&A expenses to 23% of sales. As a result, operating income remained stable at 2.9% of sales, though it did grow 5.7% to $313 million. Taxes also fell as a percentage of sales but losses from non-controlling interests pushed net income growth to a negligible 1.3%. Higher shares outstanding resulted in flat earnings of 36 cents per diluted share. This was well below the 50 cents analysts were expecting.

Guidance
Despite the earnings miss, Best Buy stuck to its full year guidance. It projects operating margins to eventually reach 5% of sales and return to levels seen as recently as two years ago in fiscal 2008. Analysts currently expect sales to increase 6% to just under $53 billion and earnings of $3.53 per share.

The Bottom Line
Best Buy stated it gained a percent of domestic market share during the quarter, which is probably still due to the demise of arch rival Circuit City and a handful of more regional players. However, the significant earnings miss has raised a potential red flag as to whether existing competitors, including hhgregg (NYSE:HGG) and especially Wal-Mart (NYSE:WMT) are becoming more aggressive on pricing to gain market share.

So far, Best Buy believes it can boost profitability while gaining market share and has maintained its goal of 5% operating margins. Its focus on providing customer service for a more hands-on customer experience when it comes to purchasing and installing televisions, computers, and other electronics is definitely a competitive advantage, but price is also extremely important, and many products are commodities sold by other big-box retailers. This coupled with a tepid economic recovery and flat panel-TV weakness leave the shares close to fair value and forward P/E under 11.


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