On Tuesday, Best Buy (BBY) reported poor fiscal third-quarter results that showed modest comparable store sales growth but material operating-income deterioration. Though results of the world’s largest electronics chain came in lower than our expectations during the quarter, Best Buy reaffirmed its adjusted diluted earnings per share guidance range of $3.35 to $3.65 for the year. Nevertheless, we are placing our fair value estimate for Best Buy under review while we re-evaluate the implications of its aggressive pricing actions on long-term profitability. We expect to lower our fair value estimate for the retailer materially.
Best Buy’s total revenue increased 1.7% during the period thanks to modest domestic same store sales expansion led by its online channel, offset by international performance at small box stores in Europe open for at least a year. This performance is in stark contrast to the results of the same period a year ago, which witnessed significant comp declines domestically and solid expansion internationally. Best Buy noted particular strength in mobile computing (including tablets), appliances, eReaders, mobile phones and movies, but weakness in digital imaging and gaming. We suspect most of the sales growth was driven by increased promotional activity to drive increased traffic, as gross profit dollars declined 2% from the prior-year period. We view this trend as particularly worrisome, given the firm’s fixed square-footage overhead (brick-and-mortar locations) and the stiff competition it faces from Amazon (AMZN), Wal-Mart (WMT) and Target (TGT).
Overall, adjusted operating income fell 15% led by nearly a 30% fall off in the firm’s domestic operations, while adjusted diluted earnings per share dropped 13% in the quarter, to $0.47 (we had been expecting earnings north of $0.50). Free cash flow, however, was robust, and the company’s dividend and buyback program remain intact.
Looking at full fiscal 2012 guidance, Best Buy expects comparable store sales in the range of flat to a 3% decline. Gross margins are expected to fall, while overhead is anticipated to increase 2%, leading to expectations of adjusted operating income dollars to be in the range of a 5% decline to 2% growth. All things considered, we were not impressed with Best Buy’s performance and don’t think this bodes well for smaller electronics retailers like hhgregg (HGG) and RadioShack (RSH), or fourth-quarter earnings season, in general.