Another quarter is in the books, and there's scarcely any good news at struggling retailer Best Buy (NYSE:BBY). While there is still a chance that founder Schulze will come back with another go-private bid, the fact remains that comps continue to erode and the electronics brick and mortar retailing landscape is a grim one. With Best Buy's management talking about wooly concepts like "reinvigorating the customer experience," investors would do well to approach this turnaround candidate with considerable caution.

Forex Broker Guide: Using the right broker is essential when competing in today's forex marketplace.

Not Much to Celebrate in Q3
The best thing I can say about Best Buy's third quarter is that the sales and operating expenses weren't really any worse than expected. That said, cash flow is deteriorating and a big inventory build for the Christmas shopping season represents a gamble that Best Buy can ill afford to lose.

Revenue declined more than 3.5% this quarter, with overall comps down 4.3% (despite an easy year-ago comparable of negative 0.7%). Domestic revenue fell almost 5%, as comps declined 4% and store closures occured. International revenue was flat, though comps declined a bit more than 5%.

Margins were a decidedly mixed bag. Best Buy missed the gross margin target by about half a point, due to a negative mix shift that included more smartphone sales, a higher proportion of TVs with smaller screens and clearance sales. Because of that disappointing gross margin performance, adjusted operating income tumbled almost 90% despite in-line SG&A spending.

Can This Shopping Season Turn It Around?
Best Buy is looking at a holiday shopping season with some pretty high stakes. The company is making a pretty sizable cash flow bet on inventory, allowing inventory to rise almost 5% this quarter against that 3.5% revenue decline. If Best Buy can't move the merchandise, margins and cash flow are going to suffer.

I have my doubts about Best Buy's ability to deliver. Neither Dell (Nasdaq:DELL) or Hewlett-Packard (NYSE:HPQ) had many encouraging words about the PC business, and I think this holiday season could be a letdown for those expecting big ultrabook sales. While I'm sure companies such as Apple (Nasdaq:AAPL) and Amazon (Nasdaq:AMZN) will do well with their mobile devices, that's not going to help Best Buy much, if at all. Last but not least, I haven't seen or heard anything from companies such as Corning (NYSE:GLW), Sharp or DuPont (NYSE:DD) to give me much confidence that TV sales will show a big rebound this holiday season.

SEE: Is There A Future For Best Buy?

Does Best Buy Have a Workable Plan?
At the risk of sounding like I'm piling on Best Buy, I was also not terribly impressed with the company's turnaround ideas at its analyst day earlier this month. Vague ideas such as "reinvigorating the customer experience" may have sounded good to Best Buy's executives, but they mean almost nothing to me. While I do think the company's decision to embrace showrooming, forge better vendor relationships and highlight premium brands are all good ideas, management seemed long on big-picture targets and rather short on specific deals.

On the other hand, a little perspective may be helpful. It's hard to imagine how Best Buy could have been run much worse over the past few years, and yet the company is still cash flow positive. Elsewhere, the company clearly let Amazon steal the march on online electronics retailing, but there could still be a chance to turn that around, particularly if the company can forge relationships with companies like Google (Nasdaq:GOOG).

The Bottom Line
With a half-billion dollars of debt maturing in mid-2013 and $1 billion of a $2.5 billion revolver expiring in August of next year, Best Buy can't afford to screw up this holiday season, nor let its cash flow position get substantially worse.

I still believe that the best option for Best Buy shareholders is to take a deal from Schulze, but I fear that the bid that comes between now and mid-December (if one comes at all) may be disappointing in its size - likely leading to a protracted fight. Likewise, I'm a little concerned that it has taken this long for a bid to emerge; while it takes time to get investors lined up, I think it shouldn't be taking this long unless there were some meaningful disagreements about terms.

Best Buy shares are likely undervalued so long as the company can stay in business, but the demise of other retailers such as Circuit City and CompUSA amply demonstrates that there's no guarantee of that happening. While I do personally believe that this company will somehow make it, I don't have enough confidence in current management to put my own money behind that belief.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Why did Wal-Mart's Stock Take a Fall in 2015?

    Wal-Mart is the largest company in the world, with a sterling track-record of profits and dividends. So why has its stock fallen sharply in 2015?
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  4. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  5. Investing

    Retailers Rebel Against Black Friday: Bad Move?

    The Black Friday creep may have hit a wall as some stores are shutting their doors on Thanksgiving and even Black Friday to give employees the day off.
  6. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  7. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  8. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  9. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  10. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center