Best Buy's (BBY 0.26%) latest earnings report hit all the notes that investors usually love to hear heading into the holiday season. Sales trends beat expectations again thanks to strong demand in both the online and in-store channels. Profitability increased despite rising supply chain costs. And the management team boosted its outlook for a third straight time this year.
But Wall Street wanted more. Following management's delivery of the report on Nov. 23, Best Buy share prices slumped immediately by more than 10% due to traders' fears that the boom times are ending for the retailer.
Even if conditions for the retailer are going to shift, however, that's not likely to derail Best Buy's ability to deliver strong returns.
Image source: Getty Images.
One drawback
Best Buy's Q3 earnings report was packed with good news about the business. Sales edged higher even compared to the strong results it put up in the prior-year period, though management had predicted a slight decline. Ditto for its operating profit margin, which expanded despite soaring costs.
The one hint of a challenge came around pricing. Best Buy said its gross profit margin dropped as it made greater use of promotions (i.e., price cuts) than it had a year ago.
The decline wasn't enough to erase the broader profitability gains, as operating income rose to 5.6% of sales from 4.7% a year earlier. But operating margin had been at 7% of sales through the first half of 2021. It's not clear how much of those gains will persist once the pandemic-related demand swings subside.
The hazy outlook
Management's new outlook implies that the pricing problem will get better. The holiday period likely won't include heavy promotions, CEO Corie Barry said during the Q3 conference call, since demand is high and inventory is still tight in areas like video game hardware, appliances, and mobile phones. "We have varying degrees of inventory and supply chain challenges every holiday season," Barry said, "and this year will be no different."
It's after the holidays that pricing could become more challenging for the retailer. In response to questions from Wall Street analysts, executives said the pressure for price cuts could start building over the following quarters as inventory levels stabilize.
Overreacting to the news
There are two reasons why it's crazy for investors to sell Best Buy's stock in response to that prospect. First, it's only natural that the chain would see extra pricing pressures once supply chain bottlenecks disappear. Second, Best Buy isn't forecasting an end to its operating margin expansion -- it's just noting that the unusually strong price levels of the past few quarters likely won't last forever.
Sure, it's a bit less likely that the company will be able to push its operating margin to near 10% of sales, even as consumers enthusiastically upgrade their tech products. But Best Buy is still enjoying robust demand while gaining market share in attractive areas like appliances and the home theater niche.
The sales and profit outlook improved for the third straight time this fiscal year, and the retailer is still showering investors with direct cash through dividends and stock buybacks. Those factors should all translate into market-beating investor returns, even if the promotional environment gets more competitive in 2022.
