Has Best Buy's Turnaround Been Overhyped?

It has been a tough month for shareholders of Best Buy (NYSE: BBY  ) . After announcing results for its holiday season that showed a slowdown in business, the company's shares plummeted 28.59%. This marks a drastic reversal from the company's performance over the past year, as shares had previously soared 171.7% from their 52-week low of $13.83 to $37.57 just prior to its release. Moving forward, shareholders may question whether the business is the turnaround they thought it was or if it's an overhyped company with no future in sight.

Results were poor, but there was some upside
During the nine-week period the company considers to be its holiday season, management reported that revenue fell 2.6% to $11.45 billion from the $11.75 billion it clocked during the same period a year earlier. This decline was due in part to a drop in its Domestic segment. During this timeframe, the company experienced a 1.5% drop in sales in this segment from $9.91 billion to $9.75 billion; this was mostly attributable to a 0.9% pullback in comparable store sales.

In Best Buy's International segment, the results were even worse. This segment, which includes the company's operations in places like Canada, China, and Mexico, saw sales fall 8.1% from $1.85 billion to $1.7 billion. According to the company's release, the International segment saw its comparable store sales rise by 0.1%. This was more than offset by 35 store closings between Canada and China, though. Compared to a year earlier when the segment saw its comparable store sales fall by 10.3%, this is a small victory for the company but is still far from turnaround territory.

The only positive news reported came from Best Buy's online sales. During the holiday season, online comparable sales rose 23.5% from $1.07 billion to $1.32 billion. While this shows that the company is on to something with online ordering, these operations made up only 11.5% of Best Buy's revenue for the quarter, so it is far from material.

Best Buy's track record has been mixed, but it's got company
Best Buy's lackluster results appear to be more the rule than the exception. Over the past four years, the company saw its revenue rise by 12.6% from $45 billion to $50.7 billion. While this may sound reasonable, the company was only able to grow at the expense of lower profitability.

During that same timeframe, the retailer's profitability has suffered. From 2009 through 2012, Best Buy's net income fell from $1 billion to a loss of $1.23 billion. When you look at the company's operating income, the situation looks a little better, but not much. Over the same timeframe, Best Buy's operating income fell 41.7% from $1.87 billion to $1.09 billion. The disparity between revenue and profitability can be chalked up to impairment and restructuring charges, as the company has had to write down assets and try to reposition itself for the future.

But Best Buy isn't alone in its troubles. Another retailer, GameStop (NYSE: GME  ) , has had a difficult time these past few years. The specialty retailer saw its revenue fall 2.1% from $9.08 billion to $8.89 billion between 2009 and 2012. According to GameStop's most recent annual report, most of its revenue decline has come about because of lower new video game hardware and software sales. As downloadable content continues to grow and as online sales become more widely accepted, the company will likely struggle to find solid footing.

The lower sales reported by GameStop have also resulted in lower profitability. Between 2009 and 2012, the company saw its net income of $377.3 million turn into a loss of $269.7 million. GameStop's operating income was also impaired, falling from $637 million to a loss of $41.6 million. The main driver behind the lowered profitability can be traced back to two things: rising costs and substantial impairment charges.

As of the third quarter of 2013, both companies have made some headway in returning to profitability. Compared to the same quarter a year earlier, revenue at GameStop rose 18.8% from $1.77 billion to $2.11 billion, while its net loss of $624.3 million turned into a $68.6 million gain.  This improvement has been due, in part, to a rise of new releases like Grand Theft Auto V and Pokemon X&Y. Over the same timeframe, Best Buy's revenue fell further, from $9.38 billion to $9.36 billion (or 0.2%), while its net loss of $10 million turned into a gain of $54 million.

In all fairness though, the primary drivers behind GameStop's improvement had more to do with the lack of an impairment charge in the third quarter of 2013 compared to the same quarter in 2012.  In 2012, the company booked a $678.8 million impairment, most of which related to goodwill the company wrote down. 

Excluding this impairment charge, the company's core costs (cost of goods sold and selling, general and administrative expenses) have declined quarter-over-quarter but are still above their four-year average of 91.1% of sales in aggregate.  In the third quarter of 2012, this combined metric hit 93.5% of sales but has since fallen to 92.9%.  What this means is that, even if you adjust for the impairment charge, the picture did improve but not by much. 

Best Buy saw a similar reduction in costs .  Between the third quarter of 2012 and the third quarter of 2013, the company's combined costs fell from 99.6% of sales to 98.7%. While the improvement is nice to see, the company still has a lot of work to do to bring these costs back down to the four-year average of 95.4%. 

Foolish takeaway
For a supposed turnaround, Best Buy is having a hard time living up to expectations. While the company's results weren't necessarily terrible for the holiday season, they point in the direction of a company whose prospects have been over-hyped.  

Right now, Best Buy's situation looks quite fragile.  For this reason alone, shareholders could face significant downside pressure if the company's fourth quarter earnings release on Feb. 27 isn't to Mr. Market's liking.  Even if shares do tumble further, though, it could provide the Foolish investor who is adamant about the business in the long-term to add to their position at a discount.   

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