Analyst Remains Cautious on Best Buy Shares Ahead of Earnings

Best Buy (NYSE:BBY) will report its fiscal First Quarter 2012 (April) results before market open on Thursday, May 22. Here’s what you need to know:

A Closer Look: Best Buy Earnings Sneak Peek>>

We expect Q1 results below consensus due to negative comps and margin degradation. We expect revenue of $10.9 billion and EPS of $0.49, vs. consensus for revenue of $11.5 billion and EPS of $0.60. We expect total comps in line with our estimate of down 4.1%, with domestic down 3% and international down 7%.

We expect negative international comp trends to accelerate. We expect the factors that weighed on international comps in Q4 to accelerate into Q1, particularly impacting Europe and Canada. We expect sales from Five Star stores in China to improve year-over-year, but not enough to offset weakness in other markets.

Expect continued margin degradation due to mix shift and promotions. Best Buy (NYSE:BBY) appears to have continued to drive traffic through promotional activity and value pricing, limiting deeper sales declines, but sacrificing margin in the process. In our view, profitability will continue to be challenged by an ongoing mix shift to lower margin items, particularly Apple products. We expect domestic growth segments to include Computing and Mobile Phones, Appliances, and online.

We remain cautious on Best Buy shares for a number of reasons. We believe Best Buy store traffic is driven by Consumer Electronics (which has been challenged), and think that the company’s focus on its growth segments (primarily Computing and Mobile Phones) may yield lower than expected results if store traffic continues to slow. We expect the next major product upgrade cycle for CE devices to be at least a few years away, and Best Buy’s (NYSE:BBY) stubborn pricing for items that are increasingly viewed as commodities could serve to further alienate consumers.

We think Best Buy’s long-term financial health requires substantially lower store level overhead. We believe that Best Buy’s (NYSE:BBY) store level economics place it at approximately a 10% price disadvantage to online retailers, and we believe that increasingly sophisticated consumers with mobile Internet access will value lower prices over service, ultimately making Best Buy’s big boxes obsolete.

Maintaining our NEUTRAL rating and 12-month price target of $23. Our price target reflects a P/E multiple of ≈ 7x our FY:14 EPS estimate of $3.30, and is below Best Buy’s historical 12 – 15x multiple due to continued comps declines, sluggish revenue growth, and eroding profitability.

Michael Pachter is an analyst at Wedbush Morgan.

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