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Best Buy Saw the Smartphone Slowdown Coming

By Timothy Green – Updated Apr 15, 2019 at 12:03PM

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The retailer has already taken steps to prepare for weaker smartphone demand.

The market for smartphones in the U.S. is saturated, as nearly everyone who's going to buy one already has one. And people are waiting longer to upgrade their devices. The upgrade cycle reached 32 months in the second half of 2017, according to market researcher NPD, up from 25 months in the prior-year period.

Given these dynamics, Apple's (AAPL 1.56%) surprise guidance cut to start off the year shouldn't have been all that big a surprise. While China is the biggest issue, the company also pointed to weak upgrade activity in developed markets. Apple's latest ultra-expensive iPhones aren't getting the job done.

Check out the latest Apple earnings call transcript.

A smartphone with a cracked screen.

Image source: Getty Images.

Consumer electronics retailer Best Buy (BBY 3.92%) would seem to be at risk, given that the company sells plenty of smartphones and Apple devices. Analysts at UBS reduced their price target on the stock earlier this month, partly due to the Apple news. UBS' new $57 price target is down from a previous target of $70.

But Best Buy wasn't blindsided by any of this -- the company made a move early last year to prepare for the smartphone slowdown. Weaker demand for iPhones will still sting, but Best Buy was under no illusion that it could continue to count on smartphones for growth.

Shutting down the mobile stores

Best Buy announced last February that it was shutting down all 250 of its small-format mobile stores. The company started opening these mobile stores before the original iPhone was launched, and they made sense in an era when smartphone sales growth was strong. There was good money in selling smartphones at retail when demand was growing each year.

But with the smartphone market stagnating in the U.S., the business of selling smartphones has gotten more competitive. Year-to-year smartphone improvements are no longer big enough to compel consumers to upgrade frequently, and Apple's strategy of pushing up prices probably isn't helping.

Best Buy saw this coming last year. In a letter to employees obtained by Reuters, CEO Hubert Joly said that margins had compressed as the mobile phone business matured, and that operating costs for the mobile stores were too high relative to the big-box stores. Closing the mobile stores made sense, especially since 85% of them were within three miles of a big-box store.

Still some pain ahead

The mobile stores were responsible for a bit more than 1% of Best Buy's annual revenue, so this move wasn't all that meaningful to the chain's results. But for Best Buy investors, closing those stores was an indication that the company was capable of getting out ahead of problems.

Best Buy will almost certainly still feel some pain. It will sell fewer iPhones because Apple will sell fewer iPhones. The retailer could also suffer from weaker store traffic as consumers no longer rush to buy the latest and greatest devices. That could hurt sales of accessories and related products like the Apple Watch.

Management will almost certainly discuss the challenges around the smartphone market when the company reports its fourth-quarter results in late February or early March. Best Buy's fourth-quarter guidance was already conservative, so the company may have anticipated weak iPhone sales to a degree. But even if results come up short, investors should be happy that management has a track record of anticipating problems.

Check out the latest Best Buy earnings call transcript.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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