Best Buy is worth $33, despite lower margins
Efforts to draw traffic by lowering prices hammered Best Buy's margins. But the selling has been overdone.
Best Buy (BBY) reported a sharp decline of roughly 30% in its net profits this quarter compared to the same period last year. It missed consensus analysts' EPS estimate by approximately 8%, according to Thomson Reuters.
More importantly, investors reacted negatively to the fall in gross margins sending the shares down 15% earlier last week. Best Buy competes with general retailers like Wal-Mart (WMT) and Costco (COST) as well as other specialty retailers like Radio Shack (RSH) and GameStop (GME).
We believe this reaction, while understandable, is overdone. We have revised our price estimate for Best Buy to $33, implying a near 25% premium to the current market price. Best Buy's margins have been adversely affected due to its efforts to draw traffic by lowering its product prices, and we have revised our numbers based on company guidance.
New Initiatives Are Key
In order to attract customers and boost traffic, the company lowered its product prices. This move adversely affected the gross margins. Best Buy also spent more on advertising this quarter in order to draw in customers and boost holiday sales, in particular through its direct online sales channel.
Increasing competition and volatile economic conditions have made it really tough for retailers to maintain sales without aggressive promotions and price competition. We believe that new innovative techniques could be very effective in luring customers to make buying decisions.
Best Buy has rolled out a few new initiatives that could resonate well with customers. It acquired mindSHIFT, a cloud computing company; recently rolled out more than 80 Best Buy-branded DVD rental kiosks throughout c-stores and Best Buy stores across Canada; and it's in talks to acquire a 51% stake in Next Retail, Videocon Industries’ multi-brand consumer durables retail venture in India.
While we believe that retailers will continue to face margin pressure in the coming quarters given the difficult retail environment, Best Buy's position as one of the leading specialty electronics retailers will help it navigate these challenges especially as it focuses more on its online sales to more directly challenge Amazon.
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The solid report comes a month after the retailer closed all of its Canadian operations.
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