The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Before the market open on Friday, Best Buy (NYSE:BBY) reported holiday sales results (nine weeks ending January 4), with comps down 0.8 percent (down 0.9 percent domestically; up 0.1 percent internationally) below our estimate of up 0.5 percent. Domestic growth in computing, appliances, and gaming were offset by declines in digital imaging, movies, and MP3 players. International revenues decreased due to store closings and negative FX headwindsbut experienced slightly positive comparable store sales. Best Buy will announce Q4:14 results on February 27.
Best Buy attributed domestic comps declines to the promotional environment leading to deflationary sales, supply constraints in the tablet and mobile phone categories, significant store traffic declines, and a disappointing mobile phone market. Management pointed to NPD Group’s revenue for the CE industry down 2.4 percent, while Best Buy’s CE domestic comp of down 6 percent implies to us market share losses to online competitors.
Best Buy now expects Q4 operating margin to decline 175 to 185 basis points year over year versus 40 to 70 basis points prior. The degradation in margin was due to incremental discounting to defend market share. We expect price competition to continue and expect lower operating margins for three quarters.
Management pointed out the “bright spot” that Internet sales were up roughly $200 million, while overall domestic sales declined by roughly $150 million. This implies that overall store-level sales declined by $350 million during the holiday period, triggering massive de-leverage. This is not a bright spot, in our view.
We are decreasing our Q4:14 estimates for revenue to $14.8 billion from $15 billion and our earnings per share estimate to $1.06 from $1.41 to reflect holiday results. We are lowering FY:15 estimates for revenues to $42 billion from $42.2 billion and EPS to $1.69 from $1.79, which excludes $320 million of restructuring.
We are reiterating our UNDERPERFORM rating and 12-month price target of $18. Our target is based on an EV of 10x sustainable free cash flow, reflecting expected negative comps in 2014, further margin erosion, low visibility, lack of guidance, and doubts about the sustainability of Best Buy’s turnaround plan. We expect comps declines to continue, and we expect price matching to continue to pressure margins.
Michael Pachter is an analyst at Wedbush Securities.
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