Best Buy's Turnaround Is On Track Despite Weak Sales

Source: Nicholas Eckhart on Flickr

While consumer electronics retailer Best Buy (NYSE: BBY  ) suffered from declining sales and shrinking margins during the holiday quarter, there was actually more good news this past quarter than bad. Best Buy surpassed its cost-cutting target, greatly accelerated online sales, and rolled out key initiatives which, along with aggressive pricing, led the company to grow its market share during the quarter. While profitability will continue to be pressured in the near-term, Best Buy is building the foundation for future growth.

What went right for Best Buy
Since CEO Hubert Joly took over the company in late 2012, Best Buy has been on a mission to cut costs and make itself more efficient. Joly's "Renew Blue" strategy included $725 million in annualized cost cuts, and the company exceeded that target in the fourth quarter by about $40 million. The target has now been increased to $1 billion, with the bulk of the additional cost cuts expected to come from revamping how the company deals with returns and replacements.

These cost cuts allowed Best Buy to lower its prices to make itself more competitive without completely wiping out profits. Margins did decline year-over-year but so did selling, general, and administrative costs, both in absolute terms and as a percentage of revenue.

Source: Corporate SEC Filings

Best Buy's recently announced decision to fire 2,000 managers, mostly middle managers who oversee product categories at multiple stores, is a sign that Joly is cutting out layers of management that add to costs without contributing much to the customer experience. With customer service being one of the key tenets of the Renew Blue strategy, only positions that don't deal directly with customers were eliminated.

Online sales exploded during the fourth quarter, rising by 25.8% year-over-year. This is a significant increase over the 11.2% rise in the year-ago quarter, and it's six percentage points higher than the full-year number. This suggests that online sales growth accelerated during the fourth quarter.

A big part of this acceleration came from Best Buy's ship-from-store program. Going into the holiday season, 400 of Best Buy's over 1,000 U.S. stores acted as mini-distribution centers, fulfilling online orders along with the company's dedicated online distribution centers. This largely solved the problem of customers being unable to order a product online because the distribution center was out of stock, and as a nice side effect the average shipping time decreased. Best Buy reduced its delivery window by two days on average, and the company managed to have a shorter average delivery time than Amazon (NASDAQ: AMZN  ) during the holidays.

With over 1,000 mini-distribution centers across the United States, Best Buy has a serious advantage over online-only retailers like Amazon. Not only have shipping speeds improved, but customers have the option to pick up items directly from a Best Buy store after ordering online. The free two-day shipping that comes with Amazon Prime is nice, but Best Buy can put products into customers' hands on the same day of the order. As Best Buy continues to improve its e-commerce channel, its move to leverage its store base in order to improve the online shopping experience is something that online-only retailers simply can't match.

Looking ahead
With the first full year of the turnaround behind them, Joly and company can now build on the foundation that was built in 2013. The biggest opportunity in terms of cost-cutting is revamping how Best Buy deals with returns, replacements, and damaged items. This is responsible for more than $400 million in annual losses, and much of the additional cost-cutting in 2014 will come from reducing this number.

Allowing returned items, as well as clearance items, within stores to be sold online is one of the key initiatives for 2014. Now that the ship-from-store program is completely rolled-out, selling returns and clearance items should become simpler and less costly for Best Buy. The increased inventory available online, including both normal merchandise and returns, should allow Best Buy to continue to grow online sales at a breakneck pace.

Best Buy's balance sheet is stronger than it was at this time last year, with $2.9 billion in cash and investments and a net cash position of $1.2 billion. This compares to $1.7 billion in cash and roughly $1.7 billion in debt at the end of the year-ago period, with the exclusion of Best Buy Europe which was sold during 2013. This gives Best Buy the flexibility it needs to complete its turnaround.

The bottom line
While Best Buy's fourth-quarter results appear disappointing, the progress that the company has made over the past year has been nothing short of impressive. Best Buy has strengthened its balance sheet and made investments in its e-commerce channel that have significantly boosted sales, and it has even more cost cuts planned for 2014. The turnaround is a multi-year effort, and while short-term results will be pressured Best Buy is in good shape going forward.

How to take advantage of a changing retail landscape
While Best Buy's turnaround presents an opportunity to investors, there are other retailers with just as much promise. To learn about two retailers with especially good prospects, take a look at The Motley Fool's special free report: "The Death of Wal-Mart: The Real Cash Kings Changing the Face of Retail." In it, you'll see how these two cash kings are able to consistently outperform and how they're planning to ride the waves of retail's changing tide. You can access it by clicking here.


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