Best Buy... Disappoints?

By Dave Marino-Nachison (TMF Braden)
December 14, 1999

One of the high-fliers of the late 1990s, home electronics superstore retailer Best Buy (NYSE: BBY) hasn't been able to maintain its breakneck upward pace in the latter half of 1999. Today was no exception as the shares slid following some surprising news: the company failed to meet Wall Street's quarterly earnings expectations for the first time in a while.

Granted quarterly earnings numbers don't tell nearly enough of a company's story for any responsible investor, but facts are facts: fiscal third-quarter (ended Nov. 27) earnings were $0.37 following a penny adjustment pertaining to recent SEC guidance, missing Wall Street's consensus estimate by that same penny. The last time Best Buy failed to outdo analyst projections was Q4 of fiscal 1998.

And so the shares fell approximately 5% to below $50 in today's trading -- not a big drop for one day but nevertheless disheartening for investors who remember the stock's summer highs of more than $75 per ticket.

Some of today's downside was likely mitigated by Chairman and CEO Richard Schulze's declaration -- placed higher up in the company's press release than the earnings themselves -- that Best Buy is close to announcing a "broad-based, long range, strategic alliance... [that] will significantly expand our capabilities as the industry leader in bringing technology to consumers."

Further details were slim, though high-speed Internet access may be a component of the deal. Some observers also took note of the recent news concerning Yahoo! (Nasdaq: YHOO) and Kmart (NYSE: KM) -- as well as reported discussions between America Online (NYSE: AOL) and Wal-Mart (NYSE: WMT) -- and considered those a hint of things to come.

Lacking much to go on regarding that development, investors turned to the company's income statement, which was flush with good news except for some cost issues that seemed to dim the receipt of today's information. Though operating income has boomed, operating margins for both the quarter and past nine months were essentially flat with year-ago levels.

Behind that is an increase in selling, general and administrative (SG&A) expenses powered by the need to boost both the sheer size and expertise of staff selling digital products, which have quickly come to represent the lion's share of Best Buy's revenue growth. Add to that ramped-up store expansion -- carrying with it a boost to the managerial trainee program -- and costs associated with outside help in integrating technology, and you start to see where some revenues might hit a detour on the way to the bottom line.

Some worry in recent weeks has also been generated by news of Home Depot's (NYSE: HD) planned move into larger home appliances, a no-brainer move for the home improvement retailer that might constrain gross profits at Best Buy and others.

Best Buy's management wants shareholders to think for the long-term, setting aside quarterly -- and perhaps longer -- slip-ups (if you can call this quarter a slip-up). Looking at the company's history and balance sheet, there appears little cause for alarm and investors would do well to consider the way momentum can carry a retail stock to the promised land.

With executives dedicated not only to growth though expansion but efficiency through operational improvement, Best Buy seems a likely bet to continue pleasing investors in coming years. The company expanded its buyback program approximately two months ago; with the shares depressed on little in the way of apparent weakness, investors might want to do the same.

Related Links:
Fool On the Hill, 8/14/99, "Momentum is the Best Buy In Retail"
Dueling Fools, 5/12/99, Best Buy
Fool Plate Special, 5/3/99, "Best Buy and a Good Guy"

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