Best Buy’s Secrets to a Better Quarter: Cost-Cutting, Online Sales

Stock Market

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Best Buy (NYSE:BBY) hit the ground running Tuesday after reporting fiscal 2014 second-quarter results that beat analyst expectations. Revenue fell 11.8 percent on the year to $9.3 billion, beating the average analyst estimate of $9.13 billion. Adjusted earnings increased 23 percent to 32 cents per share, beating the average analyst estimate of 12 cents. Shares jumped as much as 11 percent in morning trading.

The top-line contraction was primarily a function of declining comparable store sales. “As expected, domestic comparable store sales were down 0.4%,” President and CEO Hubert Joly said in a company release. ”But this was driven by short-term disruptions caused by the retail deployment of the Samsung Experience Shops, Windows Stores, and floor space optimization, as well as our continuing rationalization of non-core businesses. Excluding these impacts, Domestic comparable store sales were flat to slightly positive for the quarter.”

Domestic revenue increased 0.1 percent on the year, led by revenue gains from new Best Buy Mobile standalone stores. Comparable online revenue increased 10.5 percent to $477 million, while comparable online demand increased about 16 percent.

The success of Best Buy’s online operations will be critical to the company’s longevity. This time last year, speculation that competition from online retailers like Amazon (NASDAQ:AMZN) and big-box retailers like Wal-Mart (NYSE:WMT) would drive Best Buy out of the market. The company’s stock price hemorrhaged from March 2012 to the end of the year, falling more than 40 percent before turning around with the holiday shopping season.

Since then, the stock has been on a tear. Investors have piled back in, driving up shares more than 160 percent this year to date as the company’s restructuring program — called Renew Blue — appears to be working. Joly commented in the second-quarter report that the company has reduced total annual costs by $390 million over the past nine months and is targeting $335 million more in cost savings. The short-term icing on the cake is that the company received $229 million net of litigation costs as the result of a settlement with TFT-LCD manufacturers accused of price fixing; the $30 million received during the second quarter was not included in non-GAAP financial results.

But the news was not unanimously good. The company does still face headwinds, and management was upfront about the challenges. Sharon McCollam — Best Buy’s executive vice president, chief administrative officer, and chief financial officer — commented on two factors that could negatively impact third- and fourth-quarter results:

“The first is a temporary increase in our mobile warranty costs that is expected to continue through Q1 FY15. This temporary increase is related to higher claims frequency on our legacy Geek Squad Protection programs that will expire or be operationally restructured over the next several quarters. The second is a longer term change in the economics of our private-label credit card program that is being sold by Capital One to Citibank in the third quarter of this year. This impact is due to the expiration of our previous agreement with Capital One which offered Best Buy substantially better financial terms than what is commercially available in the market today due to changes in both the regulatory environment and general consumer credit market overall.”

One important development during the quarter was the completion of the sale of the company’s 50 percent interest in Best Buy Europe, for which it received $526 million in cash plus another $123 million from the sale of related stock. Best Buy will also receive a payment of $39 million on the first and second anniversary of the closing, which is something to look forward to.

Best Buy is trading at a reasonable forward price-to-earnings multiple relative to its main competitors. A potential reason for this may be because Best Buy does not have high growth potential. On the other hand, the company could still have more room to go up in price and is undervalued at the moment. Currently, Best Buy enjoys a healthy return on assets percentage and operating margin — even though this margin has declined due to its recent price cutting initiative.

BBY WMT COST AMZN
Forward P/E 12.41 12.85 21.96 88.76
Operating Margin 2.15% 5.93% 2.91% 1.04%
ROA 4.62% 8.73% 6.59% 1.71%

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