Best Buy Hones the Edge
Nat Worden
06/13/05 - 07:06 AM EDT
Even though its stock is up 8% this year,
Circuit City's (CC Quote) decision in March to reject Highfields Capital's buyout offer hadn't looked like a good one until last week, when its shares finally nudged above $17.
The stock's support will be tested this Friday, when Circuit City reports earnings. Expectations are low. The consensus of Wall Street analysts is for the electronics chain to lose 2 cents a share, according to Thomson First Call. Worse than that and the stock could take lumps.
It's the other way around at competitor
Best Buy(BBY Quote), which has seen its stock fall 1% this year but has a decent shot at beating the 30-cent-per-share consensus when it reports Tuesday.
"Between these two competitors reporting next week, Best Buy is the most likely to exceed consensus estimates," says Rick Weinhart, a Harris Nesbitt analyst who does not own shares of either company and whose firm has no investment banking relationship with them. "Just on the basis of potential share repurchases alone, Best Buy looks poised to do well."
Best Buy has taken a number of steps that could produce upside, including shifting investment from expansion into older stores. Wall Street has also heard reports that shopping picked up during the quarter.
Danielle Fox, an analyst with Merrill Lynch, said in a research note that customer traffic was "brisk at Best Buy and slow to moderate at Circuit City" this spring. The implications are that, even amid concern about a softening of consumer spending in the space, Best Buy is continuing to steal market share.
Same-store sales estimates could back the theory up. Fulcrum Global Partners analyst Stacey Widlitz predicts Best Buy will report first-quarter comps up 2%, while Circuit City will post a decline of 2%. Upside to Best Buy's earnings estimates is "not unlikely" since its comps may well be running at 3% or 4%, Widlitz says.
Still, a stellar performance from Best Buy is not exactly unanticipated. Despite its lackluster performance so far this year, the stock has jumped better than 20% since mid-April. At current prices, shareholders might not get any immediate gains from an earnings beat next week.
Its early-year struggles stem from a disappointing fourth-quarter performance, in which Best Buy reported earnings at the low end of its guidance and lowered its forecasts for the year. The news appeared to confirm that consumer electronics was in the midst of a slowdown. Circuit City missed its own estimates for the quarter, but its comps essentially broke even, while Best Buy posted a historically small gain of 2.8%.
"All things considered, that was a good quarter for Circuit City," Weinhart says. "I viewed it as a substantial closing of the gap between Circuit City and Best Buy on a same-store sales basis."
Circuit City, which rejected a $17-a-share buyout offer from Boston hedge fund Highfields Capital in March, did a few things Wall Street liked during its first quarter. The retailer made several key management changes, it held its first analyst conference in years, and it offered decent sales guidance for 2005. The company predicted its total sales would rise between 3% and 6%, its same-store sales would rise somewhere in the low single digits, and said it planned to open 30 to 40 stores this year, including 12 to 17 moving to new locations.
"Circuit's execution on its turnaround looks more credible this year," Widlitz says. "They still have a variety of concerns in the short term. They are stuck in some undesirable real estate positions, and they are still up against a best-in-breed competitor. But the story has definitely changed from last year."
Meanwhile, Best Buy faced concerns that the rollout of its Customer Centricity format, expected at 150 to 200 of its stores in 2005, might yield growing pains. The program was added in 67 of its stores last year, and so far, the results have been favorable. The stores have recorded a marked improvement in same-store sales, sales per square foot, operating income dollars, employee engagement and customer loyalty metrics, according to Lehman Brothers analyst Alan Rifkin.
"Most people think Customer Centricity is a positive for the company, but any time you go through this kind of change there is a potential for a bump," Weinhart says. "This is the year they are really making an aggressive push in rolling it out, so if there is going to be a year where we see a hiccup in the process, this is probably the year where you would expect it."
Weinhart will be listening closely on next week's conference call for any details about the progress of the rollout. Despite the risks involved, the program, which alters the company's selling floors in stores to accommodate a wider variety of customers, should be a benefit in the long run, judging from its history of Best Buy's execution. Meanwhile, Widlitz predicts that consumer electronics will shift back into high gear in the second half of 2005 as customers start flocking for lower-priced digital televisions.
"Investors thought last year was the year of the digital television, but I actually think the second half of this year is really going to see units ramp as prices come down," Widlitz says. "Some people are concerned about margins, but the more prices come down, the more customers these companies will have. I think this is where these two stories will play out."
In addition to digital televisions,
Microsoft (MSFT Quote) previewed its Xbox 360 on MTV on May 12. When Xbox launched in 2001, Best Buy saw a 300-basis-point sequential increase in comps, and Rifkin says another such boost could be in the cards.
"While it is still about six months until the Xbox 360 hits the shelves in November, we believe the introduction of next-generation gaming consoles could benefit consumer electronics retailers this holiday season and through 2006," wrote Rifkin in a recent research note. Lehman regularly trades shares of Best Buy, and the firm has a noninvestment banking business relationship with the company.
If these product cycles arrive while consumer spending is still healthy, both these retailers should benefit. But if they had to choose between them, most analysts would go with Best Buy.
