Update: Best Buy, Ames Get Pummeled After Warnings

Updated from 11:39 a.m. EST

Investors bailed from Best Buy(BBY Quote) Thursday, driving its shares down 38% after the electronics retailer warned that its profits for the rest of the year would sag amid a tougher economic climate.

Best Buy, which sells computers, software and appliances as well as electronics, explained that it had increased promotional activity at its stores to attract more reluctant consumers, but the efforts likely would lower its earnings and gross margins.

"The issues affecting Best Buy are identical to those every other retailer is experiencing," said Aram Rubinson, who tracks the company for PaineWebber. Heightened competition along with higher interest rates and fuel prices have had an adverse impact on retailers like Best Buy.

Despite the poor results, Best Buy has taken "reasonable and responsive" steps to address the hostile retail environment, saying it would consider delaying the opening of new stores and would "put capital expenditures under the microscope," Rubinson said.

For now, though, the company must brace for some turbulence. In the third quarter, Minneapolis-based Best Buy said it expects to record earnings of 27 cents a share, well below the consensus analysts' projection of 44 cents a share, according to First Call/Thomson Financial.

And the situation won't improve by the fourth quarter, when Best Buy expects to post profits of 90 cents a share, lower than the anticipated $1.02 a share.

"We are experiencing lower gross margins as retailers fight to gain market share in a more cautious consumer environment," Best Buy Chief Financial Officer Allen Lenzmeier acknowledged in a statement.

Wall Street was unforgiving. Best Buy's stock closed Thursday regular trading down $20.13 to $32.25 after reaching a 52-week low of $33. Its shares took a beating last month after Circuit City(CC Quote), its rival, said it would miss its third-quarter earnings mark because of sluggish sales of electronics and office supplies.

Circuit City had previously announced it would abandon the appliance business to focus on more profitable products. The departure, however, failed to stimulate Best Buy's appliance sales as the company had optimistically expected, Best Buy executives said in a conference call Thursday.

Fresh competition in the appliance sector has rushed into the void, they said, restraining Best Buy's sales. Adding to the frustration, sales results at some of the company's new stores have been lackluster, according to company officials.

Best Buy is certainly not alone. Saying higher fuel prices and interest rates have slowed down consumer spending, Ames Department Stores(AMES Quote), the discount retailer, reported a wider-than-expected third-quarter loss and predicted a lackluster fourth quarter.

Rocky Hill, Conn.-based Ames also said Thursday that it would close 32 stores, cut 2,000 jobs and take a charge of up to $140 million in the fourth quarter. Its shares promptly ended down $1.81, or 39%, to $2.91 after reaching a 52-week low of $2.25.

Ames said it posted a third-quarter loss of $37.2 million, or $1.27 a share, compared with a loss of $27.7 million, or 95 cents a share, a year ago. And in the fourth quarter, Ames said it expects earnings of $2 a share, which would lead to a loss of $1 a share for the full fiscal year.

"We are taking prompt corrective action now, so that we can be properly positioned for an improved year in 2001, despite the retail climate," Joseph Ettore, the company's chairman and chief executive, said in a statement.

Faced with unfavorable economic factors, retailers must focus on what they can control. "It's sort of a grin and bear it time," said Rubinson of PaineWebber, which rates Best Buy's stock a strong buy and has not done any underwriting for the company.

"They just have to continue to make sure that they're doing the right things," he said.