The formerly beaten-down Best Buy Co. Inc. was one of the better buys of 2013, as the shares tripled. Cost cuts, competitive pricing, better product mix and new emphasis on Internet selling were all adding up to a compelling turnaround story for North America's dominant consumer-electronics retailer.
At least until last week, when it released the preliminary results of the holiday shopping season.
Best Buy had been expected to price its products competitively and show gains in sales. Any hit on gross profit margins would be partially offset by cost-cutting elsewhere in the business.
Instead, the company revealed that same-store sales, a key measure of revenue at locations open for at least 12 months, fell by 0.9 per cent. And margins were much worse than expected. Since the holiday season represents an outsized portion of any retailer's results, the news will pretty much wreck the fiscal year that ends next week. The shares fell nearly 30 per cent.
Just a blip? Many of the analysts bullish on Best Buy, while admitting they were wrong about the past holiday season, suggest the shares are still a good buy. And it's entirely possible the shares will show life later in the year if management can turn some of these numbers around.
Investors would be wise, however, to take a step back and look at the long-term trends in electronics retail (hint: It starts with "I" and ends in "net") and avoid buying Best Buy for anything more than short-term speculation.
You might say I've been wrong about Best Buy twice, but I think it's only been once. In June, 2011, I recommended the stock when it was about $26 (U.S.), with a forward price-to-earnings ratio of about eight. "The stock is so cheap it's as if the market believes no one will ever walk into a physical store to buy electronics again."
This is the sort of absolutist statement that gets investors, or those who advise them, into trouble. Of course, people were still going to shop at Best Buy. The problem is that the number of Best Buy shoppers was getting smaller, faster, as people shifted their purchases to the Internet.
And companies with significant cost structures (think a large retail chain of big physical stores) have a problem when sales fall: Costs must be cut to recapture profits, until sales fall again, requiring more cost-cutting.
I renounced my "buy" on Best Buy at the end of 2011, when the shares had fallen 20 per cent (on their way to losing half their value). And I demonstrated my new view of big-box retailers generally in June, 2012, when I warned against shares of office-product retailer Staples at $12.
Here's where you might say I was wrong the second time: Best Buy had that dramatic 2013 performance, and, at one point, Staples stock had gained more than 40 per cent from the day of that 2012 column.
Both, however, have reversed and are just about back to where they were when I soured on them, which means they've trailed the overall market badly. I think that's appropriate.
Scot Ciccarelli of RBC Dominion Securities' U.S. affiliate is maintaining his "outperform" rating on Best Buy, "despite massive frustration levels" with the company's holiday performance. He says the shares "will be in the penalty box for a few quarters as investors try to assess whether this holiday season's results were temporary due to the extremely promotional overall retail environment or a signal that the bull thesis … is a mirage due to secular pricing pressures in the space."
I recently set foot in a Best Buy in the days before Christmas. An out-of-town relative bought me a gift and I was using store pickup to get it. I saw a DVD set that I wanted to buy. It had a list price of $100; Best Buy charged just under $80; I went home and bought it on Amazon.com for less than $40.
I'm going to go ahead and suggest, to use Mr. Ciccarelli's phrase, that there are secular pricing pressures in the space. Which just might mean that the bull thesis is indeed a mirage.