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Best Buy's (BBY) Bid to Be the Cheapest Hurts Profitability

NEW YORK (TheStreet) -- Best Buy's (BBY - Get Report) third-quarter earnings, though ahead of Wall Street forecasts, were overshadowed by thinning gross margins and tempered expectations for the upcoming holiday shopping season. Shares tumbled 5% to $41.40 in premarket trading.

For three months ended Nov. 2, the electronic retailer said its gross margin rate fell 60 basis points in the U.S. to 23.6% and management expects an equally depressed figure over the all-important holiday season quarter.

"If our competition is in fact more promotional in the fourth quarter, we will be too and that will have a negative impact on our gross margin," said Chief Financial Officer Sharon McCollam in a statement. "We too are opening our stores at 6:00 pm on Thanksgiving Day and not closing them until late evening on Black Friday. This requires increased promotional offers and an incremental investment in store payroll."

Expectations were high for the world's largest electronics chain after the implementation of a strict cost-cutting and turnaround regime dubbed "Renew Blue." For the quarter, the company reported net income of 18 cents a share, beating estimates by a nickel. Revenue of $9.36 billion was higher than the $9.35 billion analysts surveyed by Thomson Reuters had expected.

Must Read: J.C. Penney's Fight for a Turnaround

The company managed to reverse a $10 million loss suffered in the year-ago quarter, with net earnings of $54 million boosted by $115 million in cost reductions.

Comparable-store sales in the U.S. rose 1.7% and fell 6.4% internationally. Online continues to be a savior with same-store sales up 15.1% during the quarter.

"Looking ahead to the holiday season and beyond, our strategy is to continue to drive our Renew Blue transformation," said CEO Hubert Joly in a statement. "We are offering highly competitive prices, compelling promotions, and our Low Price Guarantee, as we believe that price competitiveness is table stakes."

However, as the retail game heats up ahead of a shortened holiday shopping season (due to a later-than-usual Thanksgiving Day), Best Buy is in for reduced gross margins and a tooth-and-knuckle fight to lure consumers.

Last week, investment firm Jefferies reiterated its "buy" rating and revised its price target to $52 from $40, confident in management's turnaround execution. Likewise, UBS upgraded the stock to a "buy" from "neutral" with a price target of $49, up from $35. UBS said it is believes the company can eventually produce $1 billion in cost savings and that partnerships with Google (GOOG) and Amazon (AMZN) would cement Best Buy's go-to reputation in the electronics space.

--Written by Keris Alison Lahiff.

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