Best Buy's Encouraging Third Quarter

Best Buy's stock trading at $43.58 crashed down to a low of $38.58 before rebounding today.  The price at the higher level was more inflated than the Hindenburg, and I'm sure that most technicians say that a pullback was both warranted and healthy for the longer-term.

Again, it's very funny to see the analyst at Credit Suisse who couldn't like the stock at $12 reiterating a Buy, with the undocumented suggestion of $5.00 per share in earnings power.  The only things missing are when, why and how?

Management's presentation wasn't as polished as in the past.  I know that the executive team are trying their best to give analysts what they want, in what they perceive as their own language. Management always does best when it speaks in their own natural language, expressing who they are and how they think.

The somewhat arbitrary logic of the points presented by the CEO, and the rapid fire basis point differentials between the next quarter and the present quarter for key ratios was hard to follow on the call.  For the CFO to then state that the company was not giving guidance may have been technically correct, but it was also confusing.  Analysts should then make their own revenue projections, plug them in, and then check their margin percentages to make sure the changes fit those given, I guess.  Over time, I hope that they come back to the simpler, clearer, more measured approach that characterized Hubert Joly's first presentation that really calmed the roiling seas when he took over as CEO.

Third quarter fiscal 2014 revenues of $9.4 billion declined 0.2% y/y, due to the effect of store closings in the interim period from the prior year quarter, and softness in international sales, particularly Canada and China. Non-GAAP EPS of $0.18 versus $0.04 was better than expected. Domestic revenues of $7.8 billion increased by 2.3% y/y, which was good news, driven by a domestic same-store sales increase of 1.7%.  So, the streak of declining same-store sales has been broken ahead of the holidays, which seemed like a litmus test for shareholders to believe in the story beyond cost cutting.

Domestic online sales increased 15% over the prior-year period.  So much for show rooming and Amazon. The CFO mentioned the strength of domestic pre-orders for new video game systems and software.  Most of this revenue will be recorded in the fourth quarter of fiscal 2014.  Were these orders recorded as revenue in the current quarter, domestic online sales would have increased over 20%.  New product introductions have always been critical for specialty retailers like Best Buy.

The Renew Blue cost savings programs appear to be on track faster than expectations and faster than those of other mega-cap companies I've followed over the years.  This speaks to the acuity of the current team, and it raises the question of what on earth was going on before they arrived?

In our post of November 16, 2012, we wrote,

"They are shown to have one of the largest customer loyalty data bases in the industry, but it isn't an effective program, especially for inducing activity among inactive customers.  Office Depot, for example, has a better program that requires no customer effort to update and use. This can be easily fixed. 

Best Buy's website looked like something from the 1970s, and the navigation and functionality were primitive.  It looks a lot better since Mr. Joly has come on board, and it can do much, much better.  Despite this, the company drew 1 billion online visitors and generated $2.3 billion in sales from the online channel. 

For all the talk about "low hanging" fruit, some of the fruit, like the operations at Best Buy Canada, is lying on the ground. The cultural and organizational issues, which are much more subtle, can yield a lot, but they will take time."

We've talked about Best Buy's having lost touch with their customers over the years.  Much of what we found the most encouraging about the CEO's introductory remarks didn't have a lot of numbers attached, but it was clear why he was talking explicitly about these issues.  The company now sees customers interacting with the company in very personalized ways.  For example, like most customers, we do extensive price and product research online before visiting a Best Buy or before visiting Best Buy online. The customer might order online, come into the store to purchase, or purchase online but come into the store for merchandise pickup.  These might be different customers shopping in different ways, or it might be the same customer shopping in different ways for specific types of merchandise.

 But, it's not all about price all the time, and Best Buy gets this.  So, in this quarter and in coming quarters, some of the savings from Renew Blue are being reinvested in Best Buy's website.  This is a no brainer, and the new CFO has done this kind of major rebuilding of the engine and the body before at Williams Sonoma.

The CEO noted their expenditures on improving site navigation, taxonomy and the results for natural language queries.  Best Buy's site was in the Stone Age when CEO Joly came on.  It's improved, but it has a long way to go. Yet the improvements made already have generated 15% y/y sales increases.

They have combined killing their previously lame customer rewards program and replacing it with a new one, attached to a new private label credit card program from Citi. The company now offers product category guides online, and allows customer reviews to populate the online guides.  In the quarter, the CEO said that the number of customer product reviews posted online went up fourfold. This is slowly catching up to the industry's best practices, but with Best Buy's size and product diversity, making the website a place where customers want to spend time and give input is a big deal for reconnecting with customers.

Best Buy Canada has wound down 15 stores, and Canada has a poor mix of sales and a strongly promotional sales environment in the prior quarter, which contributed to a sixty basis point decline in the gross margin rate.

More than 400 large format stores will soon be equipped to ship to customers from the store.  Two of the corporate distribution centers are being optimized for online order fulfillment.  Amazon is the platinum standard for online fulfillment, but the good news is that there is nothing proprietary about the building blocks of this capability.

The CEO made a couple of references to welcoming show rooming, as the Best Buy stores are great showrooms, and some of them could in effect become fulfillment centers from the same real estate. This is another big deal.

The CFO noted another orchard of low hanging fruit, namely the merchandise from customer returns.  She said, "As we've discussed, customer returns replacements and damages represent approximately 10% of our revenue and over $400 million a year in losses." (Thomson Reuters transcript) 

If the turnaround was in the second or third inning in the last quarter, it is in the top of the third or fourth at this stage.  What's been unveiled so far looks and sounds very encouraging.