Best Buy (NYSE:BBY) reported third-quarter earnings before the opening bell on Tuesday that beat analysts' expectations. But the stock opened lower because of concerns about the company's profitability heading into the all-important holiday-shopping season. Best Buy posted better-than-expected earnings of $0.18 a share for the period ended Nov. 2. Wall Street was looking for EPS of $0.11 in the quarter. Meanwhile, revenue of $9.36 billion was in line with expectations.
Unfortunately, these results weren't enough to save Best Buy stock from falling more than 8% at the time of this writing. To shed light on what's causing the sell-off today, let's examine two things investors might have missed from Best Buy's conference call this morning.
Profitability gets pinched
Best Buy said it would offer highly competitive prices during the holidays this year in an effort to keep up with discount rivals such as Target (NYSE:TGT) and Wal-Mart (NYSE:WMT). With Wal-Mart vowing to match prices on Black Friday toys and electronics deals from Target, there is tremendous pressure on Best Buy to follow suit.
As a result, Best Buy promised to uphold its Low Price Guarantee and offer more promotions and "doorbuster" deals this holiday season. The big-box retailer also plans to open stores early for the holiday this year. Best Buy locations will now be open as early as 6 p.m. on Thanksgiving Day and will remain open throughout Black Friday. Likewise, Target will open its doors at 8 p.m. on Thanksgiving, while Wal-Mart will invite shoppers to its stores beginning at 6 p.m. that day.
While it's refreshing to see Best Buy being proactive in attracting more guests to its stores, these efforts come at a cost. For Best Buy, extended holiday hours mean an incremental investment in store payroll. Not to mention, by increasing its promotional offerings to keep up with competitors, Best Buy's profitability is sure to suffer. On the call, Best Buy CFO Sharon McCollam said, "If our competition is in fact more promotional in the fourth quarter, we will be too and that will have a negative impact on our gross margin."
Vendor stores will drive performance
Fortunately, it wasn't all bad news. Best Buy's CEO, Hubert Joly, who took the helm last fall, discussed the importance of vendor stores in fueling the company's growth going forward. Vendor stores refer to the store-within-a-store model that Best Buy implemented last year when it rolled out Apple (NASDAQ:AAPL) and Samsung formats in its big-box stores.
Joly said that the mini-store format makes sense from a financial perspective, particularly because the vendors contribute to the cost of running these stores. Apple specialists hired by Apple, for example, staff the mini-Apple stores found in select Best Buy locations.
Best Buy first teamed up with Apple in 2011 and has since launched Apple-branded stores inside thousands of Best Buy locations around the country. On the conference call, Joly explained that one of the reasons this format works is because of the improved margins on these products. On top of this, being able to touch and experience both Apple and Samsung products in the same store has significantly enhanced the experience for Best Buy shoppers, according to Joly.
This should help Best Buy attract more tech-savvy customers during the holidays, especially as it stocks its shelves with Apple's newest iPhone 5s and iPhone 5c along with the company's new iPad air device. Creating a memorable in-store shopping experience is important for any retailer. But for Best Buy there's extra pressure to get it right this year.
How to play retail stocks ahead of the holidays
The world's largest consumer electronics chain has been aggressively cutting costs and closing unprofitable stores this year. Moreover, with a new CEO in charge, the stock has more than tripled this year. Nevertheless, Best Buy is still in recovery mode.