Grinch Visits Best Buy, Circuit City - TheStreet

Grinch Visits Best Buy, Circuit City

Both retailers had disappointing news Wednesday, but traders punished only the latter.
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Best Buy (BBY) - Get Report and Circuit City (CC) - Get Report each dumped coal in investors' stockings Wednesday, but only the latter's shares got tarnished.

Circuit City shares plunged nearly 7% to $10.34 Wednesday after the electronics retailer missed analysts' bottom-line estimates. Conversely, rival Best Buy saw its shares rise about 3% to $51.50, despite lowering its earnings guidance for the fourth quarter and warning investors that its holiday sales are coming in below expectations.

The differing reactions have a lot to do with the direction the companies appear to be heading in, investors say. Best Buy's fourth quarter may not turn out as good as projected, but the company performed solidly in the third quarter and looks to do fairly well going forward. In contrast, Circuit City has little success to show for its ongoing turnaround effort, highlighted by continued weakness in its sales and margins.

"Circuit City's going to continue to struggle," said Michael Wilson, a portfolio manager at Holt-Smith & Yates Advisors, which has $1.5 billion under management. "They're making a good effort to remodel their stores and change their mix inside, but whether they can catch up to Best Buy -- I don't think so."

Holt-Smith & Yates is long Best Buy, but has no position in Circuit City.

Few Bright Spots in Circuit City

In its quarter ended Nov. 30, Circuit City lost $24.1 million from continuing operations, or 12 cents a share. That was an improvement from the year-ago period, when the company lost $26.1 million from continuing operations, or 13 cents a share.

But the result was far below Wall Street's expectations. Analysts surveyed by Thomson First Call were expecting the company to lose 7 cents a share.

Part of the troubles at Circuit City has come from declining sales. In the third quarter, the company's overall sales slipped again, falling 0.6% to $2.41 billion. Meanwhile, Circuit City's same-store sales, which compare results at outlets open for more than a year, fell 1%.

But the company also lost ground on some of its costs. Circuit City's gross margin, for instance, fell 40 basis points from the year-ago period to 22.6% of sales. Gross margin represents the difference between what a company charges customers for its products and the company's direct costs of providing those products, including supplier and occupancy costs.

On a conference call with investors and analysts, company CFO Michael Foss blamed the decline in gross margin largely on falling sales of high-margin warranties. The fall-off in those warranties in turn reflected a decline in average price points of items sold in Circuit City stores, Foss said.

Without the decline in warranty sales, gross margins would have been up in the quarter, Foss said.

The company did see a decline in its operating costs in the quarter. Marketing, general and administrative expenses fell to $576.7 million, or 24% of sales from $592.1 million, or 24.5% of sales in the year-ago period.

An effort earlier this year to slash payroll costs by eliminating commissioned sales positions has helped the company reduce its operating costs. But Foss warned that Circuit City won't realize as much in cost savings from the move as expected, because it has had to add part-time sales positions to its stores.

Foss acknowledged that the company's expenses are still too high. "We have a lot of work to do," he said.

As it has been its pattern in recent quarters, Circuit City declined to give guidance for its upcoming quarter. Analysts are expecting the company to earn 53 cents a share on $3.38 billion in sales in the holiday period. Last year, the company earned $75.35 million, or 36 cents a share, on sales of $3.19 billion. But that includes the results of its credit card operation, which the company sold recently.

Best Buy Makes Lemonade

Unlike Circuit City, Best Buy gained traction on both its gross margin and its operating costs in the quarter. As a portion of sales, its gross margin increased 40 basis points to 24.8%. Meanwhile, its operating expenses fell 10 basis points to 21.5% of sales.

The company's gross margin improvement stemmed from a reduction in markdowns and better handling of clearance items, company CFO Darren Jackson said on a conference call. On the operating cost side, the company's growth in same-store sales outpaced its cost increases as the company focused on cost controls, he said.

In its quarter ended Nov. 29, Best Buy earned $122 million, or 37 cents a share. That was up from the year-ago period, when the company earned $86 million, or 27 cents a share, from continuing operations.

The company's overall sales grew 17.6% to $6.03 billion in the quarter. Meanwhile, its same-store sales grew a healthy 8.6% over the same period last year.

Best Buy's strong performance in the just-completed quarter appeared to overshadow its disappointing guidance and December sales results. The company expects to grow its comparable-store sales 6% to 8% this month, but Jackson said sales in the first two weeks have been below expectations. However, he said the company expects to make up the business over the rest of the month.

Even if it does, Best Buy does not expect to meet analysts' earnings expectations in the quarter. Best Buy expects to earn $1.34 to $1.39 a share in the quarter; Wall Street was calling for per-share profits of $1.41.

Jackson didn't explain the shortfall, but noted that if the company reached the midpoint of its range, per-share earnings would be up 18% over its profits from continuing operations in the fourth quarter last year.

Best Buy's stock has dropped about 18% since Nov. 28, indicating investors suspected the company might offer disappointing guidance, said Wilson of Holt-Smith & Yates. Noting that


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have reported disappointing sales in recent weeks, Wilson said expectations for this holiday season may have been a little too high.

"People had gotten a little too optimistic," Wilson said. But, he added, "I don't think anyone is panicking that it's going to be a weak Christmas."

Ben Friedman, a portfolio manager for Dana Investment Advisors, wasn't as sanguine about Best Buy's earnings warning. The company expects its sales to top analyst estimates, he noted. Best Buy projected that its sales will come in at $8.3 billion in its fourth quarter; analysts have projected sales of $8.1 billion for the period.

"It does give me a little bit of concern that they have sales numbers that are higher than consensus but earnings numbers that are below consensus," he said. "That is a concern."

Dana Investment is long Best Buy, but has no position in Circuit City.

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