Circuit City announced today that it will remodel virtually all of its stores over the next three years. The company will completely exit the appliance business and concentrate more on consumer electronics and home office merchandise. The plan will certainly hurt the company's profits in the short-term, but it is a smart move for the long-term if Circuit City's projections pan out.
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Circuit City will completely exit the major appliance business while allocating the vacated floor space to its higher-profit consumer electronics and home office products. The entire remodeling process is expected to take about three years, but the company intends to kill its marginally profitable appliance business quickly over the next couple months. Come the crucial holiday season, most Circuit City stores will have the appliance sections cleared for other merchandise.
The company will also expand its selection of "take with" products, moving a bit closer to bitter rival Best Buy's (NYSE: BBY) self-serve retail model. Instead of ordering items from a sales clerk, many items will be directly accessible to customers, and this should speed up the buying process.
Circuit City's stock took a hit on the news today, down over 20% at this writing to a new 52-week low. There are two primary reasons behind the implosion.
First, the company said that it expects second-quarter earnings to be approximately $0.32 per share compared to the $0.35 it reported last year. Wall Street never likes it when earnings growth goes in reverse. Moreover, the company expects to have about $30 million ($0.09 per share) in onetime charges related to shutting down its appliance business, which will reduce near-term profits that much more. These charges won't be the last, either.
Second, investors are probably feeling a bit nervous about the up-front cost this remodeling will represent. If the remodeling costs approximately $2.5 million per store as the company expects, that represents about a $1.4 billion total capital outlay over the next three years. Since the company currently has less than a third of this amount in cash, that means Circuit City will be either selling stock or increasing debt to pay for this plan.
Now what?
On the other hand, the company expects large incremental sales and profit increases once the plan is completed. In its press release, Circuit City said that it expected 30% sales increases per store post-revamp, and it also expects a 30% return on its $2.5 million-per-store investment in the remodels. If these numbers pan out, then the plan makes a lot of sense
Whatever happens to Circuit City, this is a textbook case of a company trying to move resources from businesses with low profitability to ones that bring higher returns. Maximizing returns on invested capital is always a good idea.
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There's no doubt that this plan will cause significant short-term pain. Earnings over the next three years will be muddied with numerous special charges and expenses related to the remodeling. Moreover, stores in transition rarely perform as well as those that don't have empty spaces and building contractors milling about. There will also be a learning curve for the company with this new format. While this revamping is going on, significant bottom-line earnings reductions should be expected.
Will Circuit City achieve the "30/30" goals for its remodeling? Post your thoughts on our Circuit City discussion board.
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