Big box electronics retailer Best Buy (click ticker for report: ) reported weaker-than-expected results for its fiscal year 2013 second quarter Tuesday morning. Revenue shrank 3% year-over-year to $10.5 billion, which was slightly worse than the Street expected. Earnings fell nearly 50% year-over-year to $0.20 per share, which was significantly worse than expected, driven by gross-margin compression of 110 basis points, to 24.3%. Management announced Hubert Jolly will take over as CEO, but because the back half of the year is so uncertain, the firm was unable to give investors earnings guidance.
Though results came in below expectations, we think they weren’t as terrible as some may have assumed. In addition to maintaining market share year-over-year, US same-store sales fell 1.6%, significantly better than last year’s 3.7% decline. The company continues to close stores, leading to a domestic big-box square-footage decline of 4% year-over-year and a 1% increase in sales per square feet. According to the firm, increases in tablets, e-readers, smartphones and appliances were not enough to offset declines from computers, gaming, televisions and digital imaging.
The smartphone, possibly the most disruptive product ever created, has somewhat eliminated the need for basic cameras, simple computers and MP3 players. Although we’re encouraged by Best Buy’s adoption of smartphones, we think the product could be a long-term impediment to the retailer’s survival. Contrary to popular opinion, Amazon’s (click ticker for report: ) superior pricing and lack of sales tax is only partially responsible for Best Buy’s recent decline. What may not be common knowledge is that the electronics industry is in the midst of a lull as it relates to new gadget innovation. Aside from smartphones, which also displace GPS devices, there haven’t been many must-have gadget launches in the past few years (excluding Apple–click ticker for report: –products, which we discuss in the subsequent paragraph). TV’s have become commoditized at this point, while most media has gone digital. Plus, no new gaming consoles have hit the market in several years. Simply put, another contributing factor to the decline is that there may be no reason for consumers to rush into Best Buy at this time.
For the past several years, virtually all innovation in the electronics industry has come from Apple. The iPod, iPhone, iPad and even iTunes have been game-changers. As great as these products are, there’s little reason for consumers to go into Best Buy to test out an iPad when it can be done at an Apple store. Or more likely, many consumers are already familiar with the variety of products Apple offers due to previous iterations. The one underestimated possibility is that competition heats up in the tablet space. If the Surface (click ticker for report: ) and Samsung Galaxy can pick up steam, there would then be incentive for consumers to come into Best Buy stores to try them out. Of course, that is still only a possibility, and we’re not betting on it. We hold Apple in the portfolio of our Best Ideas Newsletter.
Best Buy’s International segment faces the same challenges, but its 8.2% decline is more attributable to macroeconomic weakness abroad, in our view. The company’s balance sheet remains relatively strong, as it doesn’t have much debt. Though the firm eliminated its revenue and earnings guidance, it announced that it is on track to produce $1.25 billion to $1.75 billion in free cash flow during its 2013 fiscal year. Best Buy sports a fantastic Valuentum Dividend Cushion score, so we think the dividend is relatively safe at current levels, especially since the firm suspended its buyback program.
Not long ago, we cautioned that buying into the stock because of a possible private equity bid probably wasn’t a wise choice, and now the prospects of a bid seem to be reduced. Still, we think Best Buy is undervalued at current levels, but its score of 3 on our Valuentum Buying Index suggests there may be more downside before conditions improve. Even though the valuation is compelling, we think the risk/reward profile isn’t attractive enough for us to become interested in the stock. We’d wait for the stock to fall even further to increase our margin of safety, and our Valuentum Buying Index, which helps us avoid value traps, requires a material positive improvement in technical and momentum indicators before giving the company a thumbs-up.
Please click the following link to view our Dividend Report on Best Buy: