Best Buy: Earnings Growth Sustainable - TheStreet

Updated from 12:36 p.m. EST

Best Buy

(BBY) - Get Report

stunned Wall Street on Wednesday by reporting a far better fourth quarter than practically anyone expected and vowing to keep the cash register humming in 2005 and beyond.

Earnings at the electronics retailer jumped more than 50% to $469 million, or $1.42 a share, in the latest quarter, from $311 million, or 96 cents a share, a year ago.

Revenue jumped 21% to $8.4 billion in the latest quarter from last year, reflecting a 9.7% increase in same-store sales and the addition of 78 new stores. Analysts had been forecasting earnings of $1.39 a share on revenue of $8.4 billion in the most recent quarter.

On a subsequent conference call, the company predicted operating income could jump another 7% over the next three years on double-digit revenue growth -- a rate that one analyst estimated could lift earnings to above $4.20 a share in 2007. Consensus forecasts don't currently go out that far; one analyst surveyed by Thomson One Analytics expects the company to earn $3.45 in the year ending in 2006.

Scott Rothbort, president of LakeView Asset Management and a contributor to

Street Insight


subscription sister site, thinks the company's 7% goal is probably attainable. "If they grow 15% a year for next two years, that will probably get us to $3.70 a share in 2007," but that's minus the any favorable impacts from initiatives the company will implement this year, said Rothbort.

Shares of the $17 billion-market-cap company were recently up $3.45, or 7.1%, at $51.58.

The company issued specific upside guidance for its current quarter and year. For all of fiscal 2005, the company expects continuing-operations earnings of $2.80 to $2.93 a share on a same-store sales gain of 4% to 6%. The company said on the conference call that it sees revenue in fiscal 2005 up 11% to 13% at $27.5 billion, citing strength in home entertainment offerings like movies and music, where comps should rise in the double digits. Analysts surveyed by Thomson One Analytics had been forecasting earnings of $2.80 a share.

Rothbort thinks the company could earn around $2.85 a share in 2005. But he thinks there's a chance earnings could be as high as $3 -- a surprise, he said, that the company might be keeping in its back pocket for now.

"In the first half of fiscal 2005, we expect strong comparable store sales gains, driven by increased customer loyalty, high brand awareness and outstanding execution in the stores," the company said. "While comparable store sales comparisons are more difficult in the second half, we see opportunities to gain share and deliver operating efficiency. We are very optimistic about the year as a whole."

"This current quarter the company is in now is going to be tremendous because of tax refunds," said Rothbort, who is long Best Buy shares. He also thinks the company's customer loyalty program will continue to attract shoppers.

Meanwhile, CIBC World Markets analyst Dan Wewer sees earnings of $2.90 a share in full-year 2005, and upgraded the shares Wednesday to sector outperform from sector performer. The analyst thinks the company's current expectation should "alleviate recent market concerns over Best Buy's earnings growth potential." Wewer set a $57 price target on the stock.

Best Buy hopes to leverage a new marketing strategy for much of the improvements. The tactic, which is now about 10 months old, codifies a set of best practices for each store and tries to tailor the site to what customers in a specific market are buying. The company then tries to figure out which segments are profitable in a given area; where it can get a bigger share of spending; and how can it more efficiently service customers.

The company tested the program in 32 stores in 2004 and expects to add it to 100 stores in 2005.

The company said in fiscal 2005 it will focus on reducing costs in part by lowering supply-chain costs, payroll management and increasingly focused inventory management. It also plans to be more in control of transporting its goods, which Rothbort thinks is a good idea.

"The company is waking up and saying 'We need to be better about sourcing more goods directly from the Far East,'" Rothbort said. "That will help cut costs and increase margins." The company opened an office in Shanghai last year.

In addition, Best Buy expects to aggressively remodel this year, focusing heavily on stores that are 8 years old and older. It will also open 60 new stores in 2005 in the U.S. and 60 new stores in Canada in the next three years. Eventually, Best Buy would like 1,000 stores in North America.

In the most recent quarter, gross profit came to 25.4% of revenue, up from 25.1% last year, reflecting better promotions, better product mix and steady expenses. The expense rate as a percentage of revenue was unchanged from last year in part because of higher performance-based incentive compensation, which resulted from "the company's performance being much stronger in the 2004 quarter."

Meanwhile, Best Buy's main competition

Circuit City

(CC) - Get Report

also announced Wednesday that net income rose sharply.

Circuit City earned $89.6 million, or 43 cents a share, in the quarter ended Feb. 29, which missed analyst' estimates for 36 cents a share. The company had a profit $70.9 million, or 34 cents a share, in the year-ago period. Revenue rose 2% to $3.25 billion from $3.19 billion a year ago.

"Clearly, Best Buy is the better of the two because it has strong management, better product, and better customer focus," Rothbort said. "They're going to continue to attract people and bring them back into the stores."

The management team of Best Buy "to a great extent is a textbook MBA marketing and management focus," said Rothbort. "We shouldn't knock it. They took chances here and there. They're remodeling. They've got their act together."