The Turnaround Continues at Best Buy

Based on the stock market's reaction, you'd think that Best Buy's recent earnings report was downright terrible. The stock tumbled by as much as 10% after the company beat estimates for both revenue and profit but issued a warning regarding the negative effects of increased promotional activity during the holiday season.

The Best Buy story hasn't changed, and third-quarter results only serve to strengthen that story. In my earnings preview, I outlined three things that I'd be looking for, and Best Buy delivered on every single one of them.

Best Buy returns to growth
Companywide, Best Buy posted comparable-store sales growth of 0.3%. This compares to a decline of 5.1% in the same quarter last year, and represents huge progress for the company in a short amount of time. In the U.S., comparable-store sales rose by 1.7% compared to a decline of 4% last year, a dramatic reversal that proves that the Best Buy turnaround effort is more than just hype.

The company estimated that this measure would have been even higher, about 2%, if not for disruptions due to the continued rollout of the Windows stores. With this rollout nearly complete, further disruptions during the holiday season should be minimal.

One thing to note -- preorders for the new game consoles won't be recognized until the fourth quarter, meaning that next quarter's results should get a huge boost from the launch of the new generation of consoles.

Online sales accelerate
Best Buy has been investing in its e-commerce channel, and those investments are beginning to pay off. Online sales increased by 15.1% year over year, up from 10.3% in the same period last year. One of the reasons cited was the expansion of the ship-from-store initiative, through which online orders can be fulfilled and shipped directly from stores, increasing the amount of inventory available online. This initiative now includes more than 400 stores, up significantly from the initial test run of 50 stores.

Cost-cutting continues
Best Buy continued cutting costs in the quarter, announcing an additional $115 million in annualized cost cuts. In total, Best Buy has now eliminated $505 million in annualized costs, well on its way to the previously announced goal of $725 million.

These cost cuts balance out some of the negative effects of price-matching and aggressive pricing in general, and although the gross margin declined in the quarter, SG&A expenses declined as well. Further cost cuts should allow Best buy to continue to make price investments while minimizing the effect on the bottom line.

Why the stock crashed
Best Buy's results were solid, but investors who sent the stock tumbling focused on a warning about the holiday season. In the company's press release, CFO Sharon McCollam stated:

But as we enter the fourth quarter, we are also highly aware of the public statements that are being made by our competitors as it relates to their promotional plans for Black Friday and the fourth quarter. We know that we will be facing an increasingly promotional environment... First and foremost, we are committed to being competitive on price. As [CEO] Hubert [Joly] mentioned, it is table stakes in our transformation. So 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.

The prospect of lower margins spooked investors, but lower margins have been expected for quite some time. Best Buy had previously guided for a negative 40 to 70 basis-point impact on the fourth-quarter operating margin due to various factors, and these new concerns simply tightened this range to negative 60 to 70 basis points. Very little has changed going forward, and the outsize reaction by the market is somewhat baffling.

Best Buy is certainly facing a tough retail environment this year. The company announced that it would open its doors at 6 p.m. on Thanksgiving Day, matching similar moves by other retailers. Wal-Mart  plans to open its doors at the same time, and in the week leading up to Black Friday, the company plans big deals on toys and electronics.

The Black Friday ad for Wal-Mart has already been released, and there are some outrageous deals to be had. A 32-inch HDTV will be selling for just $98, and although it's not a major brand, it should draw plenty of shoppers into stores.

Target is offering some huge deals on electronics as well. One of the company's doorbusters is a 50-inch HDTV for only $229, as well as a bunch of other deals on TVs. Target will open at 8 p.m. on Thanksgiving Day, along with the bulk of other stores, so Best Buy and Wal-Mart will have a two-hour advantage. But shoppers will go where the best deals are, and Target is certainly no slouch in that area.

The bottom line
The turnaround story at Best Buy has not changed. The company proved that it could return to growth, with comparable-store sales rising, and cost-cutting continues to make Best Buy a far leaner company than ever before. Margins will be negatively affected this holiday season due to the increased promotional activity of competitors, but much of this decline had already been guided for. Best Buy should have a strong holiday season, and those selling in the wake of this earnings report may end up regretting that decision.

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Fool contributor Timothy Green owns shares of Best Buy. The Motley Fool has no position in any of the stocks mentioned. 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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