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Best Buy Still Has Spark

The retailer shows it can ride out a rocky U.S. spending environment.
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Updated from 9:31 a.m. EDT

SAN FRANCISCO -- Electronics giant

Best Buy

(BBY) - Get Report

rode out a shaky retail environment in the U.S. by strengthening its sales in Canada and China.

The Minneapolis-based company was able to handily beat Wall Street's expectations in the second quarter amid big growth in sales abroad and continued demand for goods such as laptops and flat-panel TVs.

The earnings beat and a bullish guidance helped boost the retailer's stock, which has been stuck near year lows amid fears that the U.S. housing and credit market troubles would cripple consumer spending.

Shares of Best Buy recently were up $2.17, or 4.9%, to $46.71.

The company earned $250 million, or 55 cents a share, in the second quarter, up from $230 million, or 47 cents a share, a year earlier. Analysts polled by Thomson Financial expected earnings of 44 cents a share.

Revenue rose to $8.75 billion from $7.6 billion a year ago, exceeding analysts' target of $8.48 billion. That included a 54% surge in revenue from international sales, which primarily come from stores in Canada and China, to $1.52 billion.

The company posted a 16.3% increase in international same-store sales, or sales at stores open at least a year. That compared with only a 1.7% increase in same-store sales domestically.

Rick Weinhart, an analyst for BMO Capital Markets, says Best Buy's domestic business was slow, but not slower than expected. He says the international business, however, is growing one-third faster than he had predicted, in part because of market-share gains in Canada, as well as a favorable currency rate and stronger product cycle.

Best Buy said its overall same-store sales, which climbed 3.6%, were led by a solid performance in notebook computers, flat-panel TVs and video gaming products. That was offset by declines in tube and projection TVs, MP3 players and CDs, Best Buy said.

The company's biggest category, consumer electronics, had a 1.6% decline in same-store sales. However, same-store sales of flat-panel TVs -- which in the past few years have been Best Buy's biggest sales driver -- rose by double-digits amid effective promotions, higher volumes and improved assortments, the company said. Overall, consumer electronics represented 38% of Best Buy's second-quarter revenue.

The home-office category, which made up 31% of second-quarter revenue, recorded a 9.8% increase in same-store sales on the strength of notebook computers. The entertainment software category, 16% of the quarterly revenue, grew its same-store sales by 9.3%.

Same-store sales of appliances, however, dropped 7.1%. Best Buy blamed the decline on the slumping housing market, but the company said it still expects to gain market share in the category. Appliances made up just 8% of second-quarter revenue.

Best Buy's gross margin rate, which has been hit in the past by price wars for flat-panel TVs, declined by 60 basis points. The company said the decline came mainly from the addition of its China business, which accounted for more than 30 basis points of the drop. It also pointed to increased revenue from lower-margin goods like computers and video-game hardware.

Best Buy noted that the gross-margin decline in the second quarter is still an improvement over the first quarter, when it fell 150 basis points. The company said it has benefited from more effective promotions.

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"We are navigating well in a challenging consumer environment," said Darren Jackson, vice president of finance and chief financial officer. "We're very pleased to see operating income rate expansion for the quarter, including less deterioration in the U.S. gross profit rate."

The company also repurchased 56.8 million shares during the quarter as part of its $5.5 billion buyback program announced this summer, reducing the number of shares outstanding by 8%.

For the full year, Best Buy expects earnings at the upper half of a range of $3 to $3.15 a share. Analysts, on average, see fiscal-year earnings of $3.03 a share. Best Buy's prior guidance called for earnings of $2.95 to $3.15 a share.

The company expects its same-store sales gain for the year to be near the midpoint of its forecasted range of 3% to 5%.

"Our optimism is balanced by the fact that approximately 70% of our annual earnings are still ahead of us in a volatile macroeconomic environment," Jackson said.

As it enters the second half of the year, Best Buy said it expects the holiday season to be a more rational promotional environment than last year, when a price war with electronics rivals as well as discount chains like

Wal-Mart

(WMT) - Get Report

and

Costco

(COST) - Get Report

battered the bottom line.

Best Buy anticipates this year's season will in part be helped by less competition, since rivals like CompUSA and Tweeter have closed stores.

Weinhart says he expects Best Buy to fare better than its competitors because of its momentum going into the holiday season. But he notes that a slowdown in the economy could hurt business, especially if competitors start cutting prices on items such as flat-panel TVs, forcing Best Buy to do the same. The same holds true if vendors slash prices.

"Our opinion is that if the economy or the consumer demand slows at all, you're going to see discounting," Weinhart says. "Once one starts, they all follow."

Circuit City

(CC) - Get Report

, the No. 2 U.S. electronics retailer after Best Buy, will report earnings on Thursday. Shares of Circuit City were up 3 cents to $10.09.

Best Buy also disclosed that it purchased a 3% stake in U.K. cellphone retailer Carphone Warehouse Group. The $183 million stake could pave the way for Best Buy to offer its Geek Squad services at Carphone Warehouse locations in Europe, the company said.