Monday, March 14, 2011

Forecast For Best Buy: Worst Is Yet to Come

by John Jannarone
Friday, March 4, 2011

Just two years after its arch rival was knocked out of the ring, Best Buy is itself on the ropes.

The company revealed a problem last December that has left investors scrambling for answers. Even with bankrupt Circuit City out of the picture, the retailer was losing market share, especially in the key television and computing categories. Best Buy shares have since tumbled 21% and now trade at a mere nine times this fiscal year's consensus earnings.

Investors shouldn't assume Best Buy simply needs time to recover. Rather, the threats it faces are likely only to worsen. Take, whose relentless growth has undercut the raison d'etre of specialty retailers. That is true both in books -- where Borders Group recently filed for bankruptcy protection -- and in electronics.

Indeed, Amazon's electronics and nonmedia revenue rose 66% to $18 billion last year, helping it lift market share in different segments. Its share of LCD TV sets, for instance, nearly tripled, to 3.7% at the end of 2010 from 1.3% in 2007, estimates research firm Traqline. Its share of portable audio devices rose to 11% from 4.6% in the same period.

A key to that success is that Amazon beats bricks-and-mortar retailers across the board on average electronics prices, a Wells Fargo study showed. Best Buy, on the other hand, traditionally hasn't tried to compete on price alone but has preferred to highlight its tech-savvy staff and wider selection.

Its selection, at least, probably meant more a few years ago, when manufacturers like Sony sold products to Best Buy but not to nonspecialty retailers. But that has changed. Sony now sells to Costco Wholesale, for instance.

And it has become much easier for consumers to compare prices -- ironically, using applications on the smartphones they can purchase in Best Buy. Shoppers can visit Best Buy stores to examine items before buying them elsewhere. Or, as Greg Melich of research firm ISI Group says, they are using Best Buy as Amazon's "showroom."

Best Buy's market share is still so big -- it accounts for nearly a third of U.S. consumer-electronics sales -- it is reasonable to assume many Best Buy shoppers make decisions primarily based on price.

That helps explain why Best Buy is exploring a switch to consistently competitive prices rather than strategically timed sales.

But history suggests changes in pricing strategies can be problematic. David Schick of Stifel Nicolaus points out that BJ's Wholesale Club decided to lower prices on some items in 2002 to defend market share. The result: Sales at stores open more than a year quickly improved. But gross margins fell for eight straight quarters. BJ's shares also fell more than 70% from April 2002 to April 2003, when rival Costco's fell just 20%. While BJ's stock has recovered somewhat since then, it hasn't caught up with Costco's.

And reducing prices might mean Best Buy has to cut costs, such as for its sales staff. That leaves the question of what a specialty retailer still has to offer.

Best Buy's edge has been apparent when shoppers wanted new technologies like LED TVs, which it sold with more success than rivals. But high hopes for 3-D television have faded, and there is nothing promising on the immediate horizon. Moreover, the major source of must-have electronics is Apple, whose own retail-store chain is increasingly a rival even as Best Buy stocks Apple products. Sales at Apple's U.S. stores rose 83% to $2.8 billion in the fourth quarter of 2010, estimates Mr. Melich, making it the third-biggest electronics retailer in the U.S.

Unless a new technology takes hold, the worst of times are likely to come for Best Buy investors.

Write to John Jannarone at

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