On Thursday, electronics retailer Best Buy Co Inc (BBY 1.95%) announced that holiday period sales increased more than expected. In the domestic segment, Best Buy reported a 2.6% rise in comparable store sales, adjusting for the impact of new smartphone installment-billing plans.
This was welcome news for investors after Best Buy whiffed on its holiday projections a year earlier, with both revenue and operating margin down year-over-year. However, before investors could get excited about Best Buy's solid Q4 performance, the company pointed to more trouble on the horizon.
Despite a solid holiday season, Best Buy is not out of the woods yet. Photo: The Motley Fool
Best Buy's bleak outlook for the next 6 months highlights its uncertain long-term prospects. While the company is much better managed today than a few years ago (prior to the ouster of former CEO Brian Dunn), making money as a consumer electronics retailer is getting harder every year.
A (brief) bump in sales
Best Buy attributed its relatively strong Q4 sales to favorable "product cycles in large screen televisions and mobile phones." Clearly the launch of Apple's (AAPL 1.25%) iPhone 6 and iPhone 6 Plus in September had a big impact on sales in November and December, when inventory was finally starting to become more readily available.
The strong sales performance will contribute to a 75-90 basis point operating margin increase compared to Q4 of FY14. This will reverse more than half of the operating margin decline that Best Buy experienced during last year's holiday quarter.
However, the benefit from strong product cycles this quarter has masked some longer-term pressures that Best Buy faces. These include price deflation for consumer electronics products and declining demand in many consumer electronics product categories.
The flip side
As the initial excitement and resulting sales rush for the new iPhones and other hit products fades in the next few months, Best Buy's management expects the unfavorable long-term trends to reassert themselves. As a result, the company's sales momentum may grind to a halt in the next few months.
After the iPhone 6 sales rush, Best Buy's comparable store sales may start declining again. Photo: Apple
Thus, Best Buy projects that comparable store sales will be flat to down in the low single digits in the first half of FY16 (running from February to July). It also expects its operating margin -- which was already less than 3% in the first half of FY15 -- to decline by 30-50 basis points in the first half of the new fiscal year.
What's the long-term story?
Despite this somber outlook, Best Buy still has plenty of defenders among Wall Street analysts. Matthew Fassler of Goldman Sachs has recommended Best Buy stock because it is the only remaining national consumer electronics store. As a result, he expects customers to go to Best Buy to learn about (and buy) products in new categories like wearables and connected home.
I remain more skeptical. Many of the biggest consumer electronics categories are past their prime. Meanwhile, competition from other big-box stores and online vendors will remain fierce going forward, keeping margins low.
It's also unclear that Best Buy will benefit from the rise of new product categories like wearables. So far, wearable technology products have flopped, and the Apple Watch is the main hope for success in this field in the future. However, the Apple Store will probably dominate sales of the Apple Watch. Third party retailers like Best Buy won't be able to offer the same kind of product expertise as the Apple Store.
Best Buy shares seem cheap to many investors. After taking a beating last week, the stock trades for only 14 times earnings: less than the stock market average.
That still might be too generous for a company that is consistently facing major headwinds and may be unable to deliver sustainable earnings growth. There are plenty of other companies -- both in retail and in other industries -- with similar earnings multiples, but much better growth prospects. Best Buy thus is not a "best buy" for value-seeking investors.
