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Best Buy proves again why it's the best
The electronics retailer posts earnings that far surpass expectations. Expect the momentum to continue.
By Robert Walberg
Best Buy (BBY, news, msgs) showed Tuesday why it remains the best pick in a sector that continues to sizzle.
The Richfield, Minn.-based company reported earnings that far surpassed expectations, and its stock jumped nearly 15% on the news. Its results also should end fears that high debt levels or steep gas prices would deter consumers from spending money on big-ticket electronic items. People can't seem to get enough state-of-the-art gadgets, and when they buy them, increasingly they're doing so at a Best Buy store.
For years, Best Buy has dominated the consumer electronics market by offering a wide assortment of products at attractive prices and in an inviting atmosphere. If the company had a shortcoming, it was service. But to its credit management heard those complaints and has been working hard over the years to improve customer service. Lines can still be maddeningly long and there are still times when it's tough to find a salesperson. But when you find a salesperson now, more often than not he or she knows the products and is helpful.
Let's face it, most of us aren't gadget geeks. We don't know the nuances between one high definition TV set from another, and we get confused by all the zoom options displayed on digital cameras. Our friends and family are all out buying this stuff though, so we know we need it, or at least we want it to keep up. But before plunking down $2,000 on a TV most of us want a little hand holding, and Best Buy is now doing a better job of removing our anxieties, closing the sale and winning customer loyalty.
Customer care
In fact, where the company has instilled its consumer-centric approach -- stores where employees are encouraged to offer suggestions to fit their customers' lifestyles -- sales and profit margins are running well above average. One of the benefits of Tuesday's big earnings number is that Best Buy now has more money to pour into retooling its older stores around this model, a move that'll only further the distance between it and competitors like Circuit City (CC, news, msgs) and RadioShack (RSH, news, msgs).
Best Buy's steady market share gains are one reason the Street so badly underestimated the company's fiscal first-quarter sales potential. Bolstered by strong demand for flat-panel TVs, digital jukeboxes, notebook computers and digital cameras, the company posted quarterly sales of $6.12 billion, up from $5.48 billion a year earlier and better than the consensus estimate of $5.98 billion.
Related news and commentary on MSN Money
Equally as impressive, gross profit margins shot up to 25.5% from 23.9% even though the average selling price of television sets went down. Limited promotional activity, cost savings, product model transitions and the conversion to the new consumer-centric model all contributed to the gross margin improvement. The company also benefited from a lower tax rate, a trend it sees continuing through the rest of the year.
Well beyond expectations
The combined effect of stronger-than-expected sales, higher-than-expected profit margins and lower-than-expected taxes produced blowout earnings of 51 cents per share, which made a mockery of the consensus estimate of 30 cents.
But the really good news is that the company sees the bullish patterns continuing. Management upped its guidance for fiscal 2006 to $3.10 to $3.25 per share from $2.95 to $3.10. It also guided fiscal second-quarter earnings to a range of 51 cents to 56 cents per share. The Street had been looking for a second-quarter gain of 50 cents.
Now you might think that the annual forecast isn't all that impressive given the scope of the first-quarter surprise and the upward revisions to second-quarter numbers. But it's important to note that management was intentionally conservative in its forecasts, noting that it might want to increase the number of store openings, conversions to the new model, etc. Based on the success the company is enjoying, who would argue with how management decides to spend its money? This is a company operating at a very high level and management deserves much of the credit.
A look ahead
All the conservatism aside, Best Buy is likely to continue posting strong earnings for the balance of this year. For one thing, last year's numbers won't be that tough to top. For another, demand for digital televisions is red hot and won't slow into the big holiday season. Toss in the upcoming demand for Microsoft's (MSFT, news, msgs) new Xbox system and the ongoing strong demand for MP3 players and the sales picture looks very promising. (Microsoft publishes MSN Money.) The lower tax rate and margin improvements generated by the new model will continue to provide a kick to earnings, too.
After Tuesday's big surge, the stock is no longer cheap. It now trades at roughly 20.6 times the high-end of management's earnings range for fiscal 2006. But it still trades at a discount to its sector despite superior performance and continued market share gains. So as long as earnings grow more than 15%, the stock deserves, and will command, a premium multiple.
How much higher the stock climbs from here is difficult to say, but this is definitely a retailer worth owning based on bullish industry conditions, operational excellence and strong financials. With the stock having exploded to a new 52-week high on big volume Tuesday, and with the promise of more good earnings down the road, investors should expect a move to at least the mid-70s by year end.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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