Tickers in this Article: BBY, AMZN, AAPL, WMT
Big-box electronic retailer Best Buy (NYSE:BBY) failed to ease investor concerns about its competitive position when it reported third quarter results on Dec. 13, 2011. An onslaught from online rivals and other big-box peers is continuing, but the fact that most investors have left the stock for dead suggests the potential for future upside.

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Third Quarter Recap
Sales improved a modest 2% to $12.1 billion. Same-store sales eked out a 0.3% increase as comps rose 0.9% in the U.S., but fell 1.7% internationally. International sales growth of 1% also lagged the domestic increase of 2%, with international accounting for nearly 27% of the total top line. By product area, appliance sale comps from brands such as Whirlpool (NYSE:WHR) jumped a surprising 13.7% to represent 5% of total sales. This was followed by an 8.8% increase in computing and mobile phone (40% of total sales) comps, as mobile devices from the likes of Samsung and Apple (Nasdaq:AAPL) continued their popular runs. The remaining categories reported negative comps, led by a 9% drop in entertainment (13%) as recorded music, movies and related hardware devices struggle.

Gross profits fell 1.7% to $2.9 billion, or 24.2% of sales as the company is fighting to compete with online rivals, especially Amazon (Nasdaq:AMZN) and keep selling prices as competitively as possible. Management was able to lower selling, general and administrative expense costs slightly, but a restructuring charge contributed to push operating income down nearly 54% to $178 million, or a measly 1.5% of sales. Lower income tax expense helped temper the bottom line decline to 29% as net earnings dropped to $154 million, though buybacks reduced the earnings per diluted share decline to 22.2% as earnings fell to 42 cents. (To know more about income statements, read Understanding The Income Statement.)

For the full year, Best Buy expects sales between $51 billion and $52.5 billion for growth of more than 4%, if it hits the high end of its guidance. It projects earnings of $3.35 to $3.65, which excludes a significant write down of Best Buy Mobile, which turned out to be a terrible investment in the European market.

The Bottom Line
Despite the profit decline, Best Buy was able to boost operating cash flow to $2.6 billion, which it attributed to "the timing of several working capital items at the end of the previous fiscal year and the continued effective management of inventory levels." It continues to use excess capital to buy back stock and support a decent dividend yield of 2.3%.

The stock dropped more than 15% after the earnings announcement to reflect continued investor concerns that Best Buy can successfully compete with online rivals that can offer lower prices given they don't have to build and support massive store locations. Other brick-and-mortar rivals, including Wal-Mart (NYSE:WMT), have also become more aggressive in selling electronics.

There will always be the need to buy larger items, including appliances and televisions from local sources. Additionally, many consumers still like to see and touch an electronic gadget before buying it, which is a key reason that Apple's physical store presence has been so successful. In other words, Best Buy will survive in some capacity, with the main question being can it return to a growth mode in the future. At the current beaten-down valuation, there is considerable upside for investors should this occur. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

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