Best Buy Short-Circuits

The retailer's margin woes raise concerns about a highly promotional holiday.
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Updated from 2:06 p.m. EST

Best Buy

(BBY) - Get Report

shares slid Tuesday after the electronics retailer missed third-quarter earnings expectations, saying intense competition put a damper on margins.

While the company downplayed the disappointing results, calling the quarter a "speed bump," the margin issues raised questions about how retail's big players will fare during an already heavily promotional holiday season.

"This is going to be the strongest consumer sector," Craig Johnson, president of Consumer Growth Partners, said of electronics, "but the question is how much money are retailers going to make at it?"

The profit concerns sent shares of Best Buy down $2.62, or 4.9%, to $51.30, and also weighed on rival

Circuit City

(CC) - Get Report

, which closed down $1.36, or 5.4%, to $23.58. Circuit City is set to post its third-quarter results next Tuesday.

For the third quarter, Best Buy earned $150 million, or 31 cents a share, up from $138 million, or 28 cents a share, a year ago.

Revenue increased 16% to $8.47 billion, driven primarily by new-store openings and strong consumer electronics sales. Same-store sales rose 4.8%.

Analysts expected earnings of 35 cents a share and revenue of $8.4 billion, according to Thomson First Call.

"While a very competitive climate put pressure on our margins, resulting in earnings below our original expectations, I continue to support the strategic choices we made," said Brad Anderson, vice chairman and CEO of Best Buy, in a statement.

During a conference call with analysts, Anderson reiterated his support for the company's strategy.

"We are not disappointed in our performance," he said. "We realize we may have a contrarian point of view, but from our perspective we are having a healthy year."

Indeed, the company said it remains on track to deliver full-year earnings of $2.65 to $2.80 because of new stores, market-share gains and expense controls. Wall Street is looking for earnings of $2.81 a share.

The company said on the call that its finish to the third quarter was "impressive," with a double-digit same-store sales gain on Thanksgiving weekend, and that those gains should bode well for the fourth quarter.

At the same time, Best Buy indicated that those sales came at the expense of margins.

"Frankly the environment was very promotional this quarter in categories like home theater and notebooks. Thanksgiving weekend was particularly more intense than the prior year," said Chief Financial Darren Jackson. "Consumer electronics is the focus for the holidays and everyone wants a piece of the pie."

Both Best Buy and Circuit City have had aggressive promotions as they look to compete with

Wal-Mart

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for in-demand items such as flat-screen TVs.

Customer Growth Partners' Johnson points out, however, that Best Buy has a strategy of offering after-market services and selling higher-price items that will help it avoid head-to-head competition with Wal-Mart.

Best Buy's Jackson said on the call that he expects a slightly more promotional environment for the fourth quarter compared with last year, but the season will be less promotional than the Thanksgiving Day weekend.

Richard Hastings, senior retail sector analyst at Smyth Bernard Sands, expects Circuit City won't have the same issues as Best Buy.

"In fact," he said, "consumer preference indicates that Circuit City's resurgence and multi-channel approach are bearing down on Best Buy in a way that didn't occur three years ago."