Outlook: Storm Clouds Gather in Best Buy’s Future

BEST BUY

Best Buy (NYSE:BBY) will report fiscal Q3:14 results before market open on Tuesday, November 19, and will host a conference call at 5:00 a.m. PT (dial-in: 877-941-0844; Conf. ID: 4649106; Webcast: http://www.investors.bestbuy.com).

Q3 revenue and earnings should beat our estimates. We estimate revenue of $9.21 billion and EPS of $(0.04) versus consensus for revenue of $9.36 billion and EPS of $0.11. We expect total comps above our estimate of down 1.1 percent (domestic down 0.5 percent, international down 4.0 percent) on strong appliance and iPhone sales.

After achieving a positive domestic comp in Q4:13 for the first time in over two years, Q1:14 and Q2:14 comps turned negative once again. Notwithstanding the likely positive Q3 comp, we expect comps to remain challenged given the lack of a large product upgrade with price competitiveness putting additional pressure on margins. The short holiday selling period could pressure comps, and we expect Best Buy to receive limited console allocations.

As of Q2:14, Best Buy’s total annualized cost reductions are $390 million. Lower costs drove profits marginally higher, but comps and margins continue to decline. Cost cuts have a theoretical limit, and we expect negative comp trends to continue long after costs are streamlined; until Best Buy can reverse its negative comp and margin trends, we cannot recommend the stock. Comps and margins appear destined to continue their downward trend. Price matching appears to be doing little to drive comps higher. We expect price competition at holiday to challenge comps and erode margins further.

Visibility remains poor. We believe the lack of revenue and earnings guidance adds a layer of uncertainty about the company’s future, particularly as comps and margins continue their long-term downward trend. Last quarter, the company implied continued pressure on operating margins, implying a sharp decline in EPS this year and next. We think the company’s inability to guide reflects a lack of confidence in its core business, and highlights the many difficulties that it faces.

We reiterate our UNDERPERFORM rating and 12-month price target of $9. Our target reflects our expectations for further margin erosion, low visibility, lack of FY:14 guidance, and our doubts about the company’s turnaround plan. We expect comps declines to continue, with price competitiveness eroding margins further

Michael Pachter is an analyst at Wedbush Securities.

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