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Best Buy’s Sales Decline Raises Doubts About Turnaround

Best Buy Co. (BBY)’s decline in holiday sales, which triggered a 29 percent drop in its stock yesterday, is raising doubts over Chief Executive Officer Hubert Joly’s turnaround strategy.

When Joly joined the world’s largest electronics chain in September 2012, he zeroed in on becoming price competitive with the likes of Amazon.com Inc. (AMZN) His theory was simple. Remove price from the purchase decision and consumers would stick with Best Buy because they can find a wide assortment of products, get advice from knowledgeable staff and test gadgets.

That approach failed to boost holiday sales in the U.S., which includes stores and online purchases. Even though the chain aggressively slashed prices, revenue from outlets open at least 14 months fell 0.9 percent in the nine weeks ended Jan. 4, the Richfield, Minnesota-based retailer said yesterday. In addition, Joly’s price cuts will narrow profit margins by twice as much as the company expected in the fourth quarter.

“The holiday results highlight the well-known secular headwinds that Best Buy still faces and raise new questions about the company’s longer-term outlook,” Brad Thomas, a New York-based analyst at Keybanc Capital Markets Inc., wrote in a note to clients.

Photographer: Tim Boyle/Bloomberg

A customer looks at Apple Inc. iPhone accessories at a Best Buy Co. store in Northbrook, Illinois. Close

A customer looks at Apple Inc. iPhone accessories at a Best Buy Co. store in Northbrook, Illinois.

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Photographer: Tim Boyle/Bloomberg

A customer looks at Apple Inc. iPhone accessories at a Best Buy Co. store in Northbrook, Illinois.

Thomas, who recommends holding the stock, projected a gain of 1 percent for U.S. same-store sales.

‘Speed Bump’

Best Buy slid to $26.83 at the close in New York yesterday for its biggest decline since August 2002. This came after the stock more than tripled last year as Joly cut costs and revived sales by dedicating more space to brands like Samsung Electronics Co.

The unexpected sales decline left Joly with the task of explaining why the past holiday-season wasn’t the norm and why it won’t repeat next fiscal year. His main defense was that demand across the industry declined and that more discounts than expected forced the retailer into deeper price cuts.

“We’ve hit a speed bump,” Joly said on a conference call with analysts. “Our sense is that it doesn’t change the overall story.”

Joly cited data from NPD Group that showed consumer electronics in the U.S. declined 2.4 percent during the nine-week holiday period while Best Buy gained market share in those products. A lack of new gadgets in the mobile-phone category also failed to excite shoppers, he said.

‘Outstanding Question’

“Yes, it’s a bump in the road, but the road is slanted downward,” said Ian Gordon, an analyst for Standard & Poor’s in New York, said in a telephone interview. “They’ve done a good job of helping slow that descent, but whether they can turn this around and start to grow earnings in a meaningful way is still an outstanding question.”

While the discounts narrowed profit margins by as much as 1.85 percentage points in the fourth quarter, Best Buy will continue the practice, Joly said. The margin erosion led analysts to cut profit projections for the fourth quarter ending this month from an average of $1.62 a share to $1.36, according to data compiled by Bloomberg. Best Buy reports fourth-quarter earnings on Feb. 27.

Total revenue declined 2.6 percent to $11.5 billion in the holiday period while domestic sales dropped 1.5 percent. One bright spot was U.S. comparable sales online, which jumped 24 percent.

Best Buy expects same-store sales in the U.S. to increase in the first quarter, Joly said in an telephone interview.

Amazon Competition

The other side of Joly’s turnaround plan for a chain that posted $1.48 billion in net losses in its previous two fiscal years is to cut costs. It now expects to trim more than its previous target of $725 million in annual expenses.

Best Buy eventually will need substantial sales growth because it can’t boost profitability through cost cuts alone, said Brian Yarbrough, an analyst with Edward Jones & Co. in St. Louis.

“You have to drive traffic and you have to do that profitably,” he said in a telephone interview. “It’s a commodity business. The worst part is that the commodity is being wrecked by a big competitor called Amazon.”

The company’s $650 million of 5.5 percent bonds due March 2021 tumbled 1.75 cents to 99.25 cents on the dollar as of 3:57 p.m. in New York yesterday, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The notes yield 5.6 percent, according to data compiled by Bloomberg.

During his first holiday season at the helm, Joly instituted a policy of matching Internet competitors’ prices. The move halted a decline in sales at the time, and Joly made the program permanent. In November, Best Buy vowed to keep pace with rivals’ discounts and said doing so would hurt profitability.

Showrooming Success

Joly said the matching policy and price cuts have eliminated the threat posed by so-called showrooming -- when a shopper looks at a product in a store and then buys at a competitor’s website. Instead of losing purchases when a shopper in a store realizes there is a better offer, Best Buy is keeping those sales, he said.

“We have transformed what people thought was a huge liability into a huge asset,” Joly said. “If prices are competitive, there is no reason to go anywhere else.”

Chains from Lululemon Athletica Inc. to Family Dollar Stores Inc. have cut profit forecasts this year after a disappointing holiday period.

With yesterday’s slump, Best Buy’s stock has declined 33 percent this year.

Best Buy founder Richard Schulze, who last year was named chairman emeritus after ending an attempt to acquire the company, said yesterday that he is confident in the retailer’s management.

“Best Buy is on this journey and in this business to win, acquire, and retain new and existing customers,” Schulze said in a statement. “I have complete faith in the long-term strategy.”

To contact the reporter on this story: Matt Townsend in New York at mtownsend9@bloomberg.net

To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net

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