The Best Buy Revival Is More Hype Than Substance
This week, Best Buy has surged to yet another new multiyear high, reaching $44.62 on Wednesday afternoon. The main catalyst has apparently been a pair of analyst upgrades from Monday. Retail analysts are increasingly optimistic about the prospects for Best Buy's cost-cutting plan to boost margins. As a result, Best Buy stock has now nearly quadrupled since last December!
But so far, the dizzying spiral of stock gains, analyst upgrades, and further stock gains at Best Buy is not backed up by much substance. EPS is expected to decline yet again this year to $2.40, before rebounding somewhat to $2.74 next year.
Furthermore, Best Buy's comparable-store sales were still declining as of the second quarter, although the company may have finally broken that unfortunate streak in the recently ended third quarter. In other words, Best Buy has not yet achieved the improvements that would justify its surging stock price. Investors should avoid the stock until Best Buy shows solid proof that its turnaround will lead to long-term earnings growth.
A growth company again?
For a long time, I have argued that Best Buy's decision to match the prices of competitors like Amazon.comwould help stem sales declines. Amazon's agreements to collect sales tax in more states have removed another competitive advantage the company has long held relative to Best Buy.
But investors are now valuing Best Buy as if it is a growth company. This seems harder to justify. While some customers have deserted "brick-and-mortar" retailers only because they found cheaper prices online, people increasingly prefer the experience of shopping online. Best Buy can meet some of that demand with a better website, but Amazon still has a big competitive advantage in the online channel as the brand most closely associated with e-commerce.
Don't count on the "shops"
Investors are also very excited about the rollout of "Samsung Experience Shops" and Microsoft "Windows Stores" inside of Best Buy. These concepts will be staffed by employees trained by Samsung and Microsoft, respectively. This is meant to improve customer service for shoppers interested in Samsung and Microsoft products.
These shops may help Best Buy pull in some additional foot traffic. But Apple's dominance of the U.S. mobile gadget market will keep this effect quite muted. This is especially true during the critical holiday season, as Apple has a much fresher product portfolio today (and seems to be setting a pattern of updating most of its products in the fall).
Thus, Best Buy may have benefited during the initial rollout of the Samsung Experience Shops this spring and summer due to Samsung's then recently released flagship Galaxy S4 smartphone. But after an initial sales surge, Samsung has encountered slowing demand. Microsoft's mobile offerings are even further behind Apple from a popularity perspective.
Best Buy can still try to sell iPhones and iPads during the holiday season, despite giving more floor space to Samsung and Microsoft. But those are very low-margin sales, especially due to the heavy price competition occurring this holiday season. Apple is also unlikely to give Best Buy any breaks now that the retailer is cozying up to Apple's top competitors. In other words, an "iPad Christmas" won't be very good for Best Buy's bottom line.
Game consoles won't help, either
Best Buy investors who have been eagerly awaiting new game consoles from Microsoft and Sony as a profit driver are likely to be disappointed on that front, too. The new console releases could provide some juice to revenue for Best Buy, GameStop, and other consumer electronics retailers. But game consoles provide very low gross margins.
GameStop has historically broken out gross margin by product category, and video game hardware produced a gross margin of just 7.6% last year and 7% the year before. GameStop can offset those low-margin sales with its highly profitable used-game business. By contrast, Best Buy doesn't have this same exposure to used games and will therefore see less upside from an increase in console sales.
In fact, if spending on $400 to $500 game consoles has a "crowding out" effect on other electronics spending this holiday season, the new PS4 and Xbox One launches could hurt Best Buy. The company's domestic gross margin was 22.4% in the holiday quarter last year. A significant shift toward lower-margin items like game consoles and iPads could lead to an even lower gross margin this year, limiting Best Buy's earnings potential.
Based on current analyst estimates, Best Buy stock trades at a very generous 16 times forward earnings. Yet the company still faces stiff competition from Amazon and others. The growth catalysts that bulls are anticipating -- such as more-competitive pricing, higher foot traffic from the Samsung and Microsoft shops, and a strong game console upgrade cycle -- are easily exaggerated.
When all the hype is stripped away, Best Buy is a retailer with stagnant sales that sells products for which having a brick-and-mortar infrastructure is not much of an advantage. The consumer-electronics market overall is not likely to grow very quickly, and Best Buy will continue to be hounded by online competitors like Amazon. Until Best Buy starts posting solid growth, I will remain very skeptical of the stock.
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The article The Best Buy Revival Is More Hype Than Substance originally appeared on Fool.com.Fool contributor Adam Levine-Weinberg owns shares of Apple and is long January 2015 $390 calls on Apple; he is short shares of Amazon.com. The Motley Fool recommends Amazon.com and Apple. The Motley Fool owns shares of Amazon.com, Apple, GameStop, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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