Best Buy Beats Earnings: Turnaround Sign or Short-Term Rebound?

Best Buy delivered better-than-expected earnings thanks to cost-cutting, but it still faces considerable danger from Amazon and other online retailers.

May 22, 2014 at 6:20PM

Best Buy Store

Source: Best Buy.

Best Buy (NYSE:BBY) stock ended the trading day Thursday up 3.4% after the electronics retailer reported better-than-expected earnings for the first quarter of fiscal 2015. Cost reductions are yielding solid results, but (NASDAQ:AMZN) and other online retailers still pose a considerable competitive challenge to Best Buy's efforts to reverse its declining sales trend.

Lower sales and higher margins
Overall sales during the quarter ended on May 3 came in at $9 billion, a 3% decline from the same period in the prior year, and lower than Wall Street's forecast of $9.2 billion. Global comparable-store sales declined 1.9%.

Sales in the U.S. fell 2.1% to $7.78 billion, while domestic comparable-store sales declined 1.3% from the year-ago quarter. Management said the decline reflected falling sales across the consumer electronics industry, pointing out in a press release that company revenue fell less than the 2.6% decline experienced by the category as a whole during the quarter, according to numbers from NPD Group.  

Quarterly domestic online revenue increased 29.2% versus the prior year, to $639 million, which was certainly one of the brightest spots in the earnings report.  However, it's important to note that online sales are already included in same-store sales calculations, so the increase was not enough to compensate for the decline in sales at physical locations.

Sales in international markets fell 10.5% to $1.25 billion. This was due to a 5.8% decline in comparable-store sales, store closings in China, and the negative impact from currency fluctuations.

Gross margin fell from 23.1% of sales to 22.4% during the quarter, but the company was able to expand its operating margin on the back of reduced expenses. Selling, general, and administrative expenses fell from 21.2% of sales to 20.1%, which enabled Best Buy to increase its operating margin from 1.1% to 2.2% during the period.

Non-generally accepted accounting principles earnings per share came in at $0.33 per share versus $0.32 in the same quarter of 2013. That was also materially better than analysts' forecast for a net gain of $0.20 per share during the quarter.

Moving forward
In the press release, the company expressed little optimism about sales trends in the medium term:

As we look forward to the second and third quarters, we are expecting to see ongoing industrywide sales declines in many of the consumer electronics categories in which we compete. We are also expecting ongoing softness in the mobile phone category as consumers eagerly await highly anticipated new product launches. Consequently, absent any major product launches, we are expecting comparable sales to be negative in the low single digits in both the second and third quarters.

Sears Holdings (NASDAQ:SHLD) also reported quarterly earnings on Thursday; performance was remarkably weak on the sales front, which management in a press release attributed mostly to particularly poor sales in the electronics division: "The biggest negative contributor to sales has been from our consumer electronics business at both Sears and Kmart."

Sears even reported sales performance with and without electronics during the quarter. Sears' domestic division overall delivered a comparable-store sales increase of 0.2% during the quarter ended on May 3, while comparable-store sales excluding electronics increased by a stronger 0.8%. Total comparable-store sales at Kmart declined 2.2%, while comparable-store sales excluding electronics fell by a much softer 0.4%.

Industry seasonality and product cycle considerations can always impact electronics sales. However, it's hard to tell to what degree brick-and-mortar retailers such as Best Buy and Sears are being hurt by these factors, as opposed to increased competition from Amazon and other online retailers, which could be a much more serious and permanent threat.

Amazon reported an impressive increase of 28% in sales of electronics and other general merchandise in the U.S. during the first quarter of 2014, to $7.83 billion, representing 66% of total North American revenue. Amazon's U.S. electronics division is already as big as Best Buy in terms of sales, and it's clearly growing at a much faster rate.

Foolish takeaway
Revenue remains weak at Best Buy. Even if cost reductions are helping margins, that's hardly a sign of a sustainable turnaround in performance. While industry headwinds may be playing a role in the company's difficulties in reversing the declining sales trend, competition from Amazon looks like a much more worrisome long-term problem for Best Buy.

Earnings were better than expected, but declining sales must be turned around if the electronics retailer wants to prevent further deterioration.

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