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Best Buy's Prospects Rebound With Q2 Earnings

8/25/2013 08:00:00 PM Eastern

MINNEAPOLIS – Best Buy turned a major page last Tuesday with a surprise second-quarter earnings increase that stunned investors and silenced critics who had written off both the retailer and big-box CE retail.

Indeed, the chain’s better than 2,000 percent profit spike, to $266 million for the three months ending Aug. 3, sent Best Buy’s stock 13.2 percent higher the day of the earnings announcement and also boosted shares of regional contemporaries h.h.gregg and Conn’s.

But beyond the income increase and stabilizing sales (revenue of $9.3 billion and comps were both essentially flat), Wall Street was wowed by the ability of CEO Hubert Joly and celebrated chief financial officer Sharon McCollam to make good on their turnaround promises under the “Renew Blue” banner.

During an earnings call last week, Joly, who joined the company one year ago this month, and McCollam, who’s been on the job only since December, ticked off a litany of strategic and operational accomplishments, including steep cost cuts; new distribution and supplychain efficiencies; improved web functionality; higher customer-satisfaction scores; increased price competitiveness; and major moves toward re-merchandising Best Buy’s stores, including the rollouts of Samsung and Microsoft departments.

Analysts were impressed. “A strong showing relative to a weak CE category,” observed Janney Montgomery Scott retail analyst David Strasser in a research note. “They are gaining share across categories and from virtually everyone in the space. We believe a re-energized sales force, a more optimized floor and stronger storelevel leadership are all driving better close rates and more Blue Shirt enthusiasm, which is driving increased market share across the store.”

Added Credit Suisse’s Gary Balter, “The progress delivered in Q2 is an important signal that Best Buy is moving in the right direction and that management’s ambitious plans are beginning to translate into better results.”

In the U.S., total revenue increased 0.1 percent to $7.8 billion during the quarter thanks to the addition of 57 Best Buy Mobile stores, while comps declined 0.4 percent due to disruptions from merchandising changes on the sales floor. These included the rollouts of the Samsung Experience Shops and Windows Stores departments; the creation of clearance sections to help offload returns; and continued “floor space optimization” as the company replaces unproductive sections like music and movies with profitable growth categories like tablets, mobile and small appliances.

Excluding the disruptions, comp sales would have been flat to slightly positive, Joly said. In contrast, online sales rose 10.5 percent to $477 million, reflecting increased traffic and higher average orders.

On the call, Joly said second-quarter improvements to BestBuy.com included the replacement of its 10-year-old search platform; the use of dynamic product recommendations for customers browsing with empty carts; easier attachment of Geek Squad services; the implementation of location-specific product offers; a campaign to quadruple the quantity of customer product reviews by year’s end, to help improve close rates; and an improved mobile site that provides “a richer tablet shopping experience.”

Joly also cited a 50-store pilot of a “buy online, ship from store” program that is addressing out-of-stocks at the company’s e-commerce distribution centers by fulfilling online orders with inventory from local stores. He said potential sales to upward of 4 percent of online shoppers are lost weekly to stock outs, although the products are often available in Best Buy stores. Pilot stores enjoyed a 90 basis point lift in July comps, with half of the items sold being either transitional or closeout SKUs that sold at higher margins than at non-participating stores. The program will be extended to an additional 150 stores by holiday.

In addition, Joly pledged an even greater investment in price competitiveness both online and off, and will use improved analytics to match or reduce prices when needed, as “our goal is not to be lower than the competition … our goal is simply to eliminate price as an obstacle to buy.”

McCollam added that the company is “proactively moving forward with price adjustments where we are not competitive,” and echoed Joly’s description of price competitiveness as table stakes. “We believe that investment in price competitiveness is the way we have to operate our business,” she said.

On the product front, mobile phones and major appliances both enjoyed strong growth, but their gains were partially offset by declines in gaming, digital imaging and other categories.

Broken out by category, majap comps rose 13.7 percent; computing, mobile phones and e-readers comps rose 2.2 percent; CE comps fell 7.3 percent; entertainment comps fell 27.7 percent; and services, including service contracts, extended warranties, computerrelated services, product repair, and delivery and installation, fell 7.2 percent.

To address the latter, Joly announced the appointment of NCR, Dell and Lenovo veteran Chris Askew as services president, with responsibility for Geek Squad and its 20,000-strong IT support staff. Askew succeeds services senior VP George Sherman, who left the company in March.

Despite the weak CE comps, Joly said the shift to larger screen sizes in TV, and the concomitant increase in average selling prices (ASPs), contributed to Best Buy’s improved comp results overall. Nevertheless, he said the preference for opening price point models by a still value-oriented U.S. consumer continues to pressure TV margins.

He added that while Ultra High-Definition and OLED displays will not have a significant short-term volume impact, “I think all of us can be excited by these shiny new objects … We love the fact that in our stores now there are TVs with a price point of $15,000, $8,000, and that’s helpful from the top-down selling standpoint.”

During the quarter the retailer received $649 million from the sale of its half-interest in Best Buy Europe; raised $500 million in a public bond offering; and received the first $30 million in a $229 million price-fixing settlement with LCD panel manufacturers. The company also trimmed another $30 million in annualized expenses, for a total of $325 million out of a targeted $400 million in cuts, and to date has reduced the cost of goods sold by $65 million thanks to an enhanced store inventory replenishment model, rationalizing its network of supply chain vendors, and the efforts to re-sell returns.

On the real estate front, the company renegotiated rent reductions for a number of stores, closed three Best Buy Mobile stores whose leases had expired, and is adding five Magnolia Design Centers and 12 Pacific Kitchen and Home stores-within-a store during the quarter.

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