Best Buy Drops 10% Despite Solid Earnings

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Best Buy Co., Inc. (BBY) reported earnings yesterday morning. The company delivered revenue of $8.9 billion and eps from continuing operations of $0.69. The company beat on revenue by $280 million and beat on earnings by $0.60. However, the stock is off over 10% post-earnings. Below is my observations on the report.

Solid Revenue Growth

In analyzing a company I like to see momentum in the top line. This is particularly important for retailers who have been under siege by Amazon (AMZN), which continues to cannibalize brick mortar stores. It has gotten so bad that investors recently bid up shares of Abercrombie & Fitch (ANF) after its revenue was flat Y/Y; investors actually thought that was victory. Best Buy’s revenue grew 5% Y/Y.

The growth was broad-based. The company saw comparable sales growth across each of its major categories. The growth was driven by strong consumer demand for technology products. I am not sure if technology alone is driving growth or a combination of rising tides lifting all boats, and Best Buy taking share from other bricks and mortar stores. Nonetheless, computers, electronics and other technology-based products appear to be items that consumers still buy in person and seek advice for before purchasing. Best Buy’s expert service and advice online and in-store is apparently resonating with customers.

Same store sales were solid; same store sales were up 5.4% domestically and 4.7% internationally. This was stellar in that Best Buy has to contend with Amazon and its own online platform potentially cannibalizing its own sales. Domestic store sales still account for over 80% of Best Buy’s revenue. Comp sales for consumer electronics and computing & mobile devices were up 2.5% and 6.7%, respectively. These two items account for about 80% of all domestic store sales.

Online Was Stellar Again

Best Buy was one of the first bricks and mortar stores to embrace online sales. Online revenue was up 31% Y/Y. At nearly $1.1 billion domestic online sales are now 13% of total domestic sales, up from 11% in the year earlier period. Domestic online is also the company’s second largest segment, outpacing international which were $640 million during the quarter. Best Buy’s positive same store sales combined with hyper-growth online portends an ability to beat back any threat from Amazon, at least for now. Management believes online is on pace to achieve over $5 billion in sales this fiscal year.

Stagnant Margins

Gross margin declined to 24.1% from 24.2% in the year earlier period. Stagnant margins have typically been caused by [i] some discounting to drive foot traffic into stores and [ii] cost-conscious customers checking prices in retail stores, and then purchasing items cheaper online. As more domestic sales are driven by online purchases the company’s mix of business is likely to continue to shift. I do not expect margin compression to abate any time soon.

Best Buy has been able to attain leverage in other parts of the business. Its selling and administrative  expense was 20% of revenue, down from 21% in the year earlier period. Last quarter the company reached its goal of $400 million in annualized cost reductions. Management recently increased that goal to $650 million. Efficiency gains allowed Best Buy to grow operating income at 11%, out-stripping revenue growth of 4%. As long as the top line keeps growing then management should be able to drive operating margins higher.

Takeaway

Best Buy is firing on all cylinders. Management also raised its full-year revenue guidance from 2.5% to 4.0%. On the earnings call management was cautious on flattish margins and heightened promotional activity. That is probably why the stock fell. I rate BBY a hold for now and could look to go long of market volatility causes the stock to pull back.

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