Slugfest in the Electronics Aisles

Most analysts see Best Buy as stronger in this now-hot market than rival Circuit City -- even more so if demand starts to droop

By Amy Tsao

Worries about sky-high gas prices, the Iraq quagmire, and a mixed-up economy have done little to lessen the desire for consumer electronics the past year. Flat-screen TVs, digital cameras, and other gadgets have been flying off the shelves -- which is great news for retailers in the sector. "Anyone selling consumer electronics is seeing a lot of growth right now," says Stephen Baker, director of industry analysis at technology market analysis company NPD Group.

Circuit City (CC ) beat forecasts for the latest quarter, when it reported its numbers on June 15. And Best Buy (BBY ) made a solid showing in its report on June 16. Those two sector leaders have already reported same-store sales gains (for stores open at least a year) of 8.3% and 6.4%, respectively, for the month of May, compared to 5.1% for retailers as a whole.

Electronics retailers have been doing so well that analysts are starting to wonder whether a downturn is due. "I'm cautious about the potential for pullback in spending on these types of high-discretionary items," says Eric Jemetz, senior equity analyst at New York City-based Rockefeller & Co. Consumers soon may face higher interest rates, and they won't have the extra cash they had in 2003 from federal income tax cuts. That could make year-over-year sales comparisons, especially in the second half, particularly challenging. (Jemetz doesn't own shares in either stock, nor does his firm.)


  That's why analysts don't think these stocks likely have much room to run in the near term after the impressive gains made over the past year. Shares in Minneapolis-based Best Buy are up 25% over the last 12 months, to around $53 as of June 15, while shares in Richmond (Va.)-based Circuit City are up close to 90%, closing at $12.61.

Over the long term, prospects for Best Buy are probably more solid. "Circuit City is still losing share to Best Buy," says Amrit Tewary, an analyst at Standard & Poor's. "Both companies have been benefiting from the broader shift to digital products, but Best Buy's market leadership is just going to widen." He rates the stock a buy and expects it can rise to $67 over the next 12 months. (Tewary doesn't own the shares. S&P has received noninvestment-banking fees from both retailers.)

Best Buy's current valuation is also more attractive. The stock trades at 16 times consensus earnings per share (EPS) of $3.36 in the fiscal year ending February, 2006. Circuit City stock trades at 25 times EPS of 50 cents for the same period. And the range for Circuit City is wide, with forecasts as low as 9 cents per share and as high as 85 cents.


  Best Buy is handily winning the contest for market dominance with neater stores, better merchandise selection, and more new-store growth. That explains many analysts' expectations that Best Buy's results should be far stronger than what Circuit City reported June 15. On June 16, Best Buy reported revenue of $5.4 billion in the quarter ended May 29, a rise of 16% from a year ago, in line with analysts' expectations. EPS in the quarter rose to 34 cents, a penny above consensus.

The main challenge for Best Buy in the near term will be beating 2003's strong monthly sales growth. In the last two quarters of that year, the retailer reported same-store sales gains of 10%, which will be difficult to improve on. Stacey Widlitz, an analyst at New York City-based Fulcrum Global Partners, rates Best Buy stock a buy, but the "upside the company has trained us to look for" isn't likely to be matched over the next several quarters, she says.

Circuit City is showing encouraging signs of progress, but not quite enough, analysts say. On June 15, the retailer, which has been in turnaround mode for the last three years, reported a net loss of $5.9 million, or 3 cents a share, in the fiscal first quarter. That's better than the 7-cent loss Wall Street was expecting, but it still reflects relatively weak revenue growth of 6.9%, to $2.07 billion.


  Circuit City beat the consensus view, but that was due to an easy comparison. During a conference call with investors, Chairman, President, and CEO W. Alan McCollough said: "We recognize improvement came against our softest performance of last year." He noted that Circuit City expects to be profitable for the current fiscal year, but adds "we recognize we still have a long ways to go ahead of us."

Profitability remains an issue. CFO Michael Foss says Circuit City is disappointed by gross profit margin levels in the quarter. For the long term, Circuit City has told Wall Street it will achieve a 4% net profit margin by the end of fiscal year 2006. Fulcrum's Widlitz, however, isn't as optimistic. She expects margins closer to 2.5% by then. The retailer also spent less on remodeling stores compared to the same period a year ago, says Widlitz.

Circuit City has been making some smart moves, including selling both the private-label credit-card and bank-card businesses to focus on fixing the stores. Still, Tewary sees the acquisition of the Canadian chain InterTAN, announced in May, as a setback. "Not only did it pay too much, but the deal will distract management from turning around the domestic business." Circuit City disagrees that InterTAN will be distracting. And the $300 million price tag of the buyout was "fair," says Bill Cimino, a spokesperson for Circuit City.

Tewary says the retailer needs to be aggressive on revamping stores and improving merchandise. "It will be awhile before they're shoulder-to-shoulder with Best Buy," says Tewary. Circuit City says it's doing a number of things in those areas. It will relocate or build 60 to 75 stores this year. And it plans to introduce Circuit City-branded products in the fall and relaunch its Web site before yearend. Tewary rates Circuit City hold, while Widlitz rates it a buy.

The unanswered question is whether consumer demand for electronics will remain strong. If so, both companies will remain hot. But if demand fizzles, Best Buy is likely the smarter long-term investment.

Tsao covers the markets for BusinessWeek Online in New York

Edited by Beth Belton

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