Why Best Buy Is Not My “Best Buy” Any More?

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Credit Suisse on last Wednesday reinstated coverage on big box electronics retailer Best Buy (NYSE: BBY) with an "outperform" rating and a $30 price target, writing in a note that outsized returns in retail happen over time in two scenarios, "management change being the primary one and acquisitions the other."

Best Buy announced its Q4 and annual results on March 1. The company reported Q4 revenue of $16.71 billion, marginally higher than $16.67 billion in the comparable period last year. It managed to bring down the net quarterly loss to $409 million from $1.81 billion in the fourth quarter of 2011. Best Buy’s results were stable in the fourth quarter due to 11% growth in online sales, driven primarily by the price matching strategy in the holiday season [Best Buy 8-K, SEC].

In this article, I will focus on Best Buy’s turnaround plan amid a weak global economic recovery, while evaluating whether it is justified to buy Best Buy’s stock at the current price.

Renew Blue initiative could turnaround Best Buy

In order to achieve its objectives for 2013-14, Best Buy has outlined certain key initiatives under the “Renew Blue” program.

  • The big focus will be on accelerating growth in the online segment. The company intends to increase online traffic, and increase the conversion rate among visitors by providing a more interactive shopping experience. The company will now track its users’ preferences based on their browsing history. They will also provide improved search tools on their sites by revamping the platform.
     
  • Big investments are being made to improve the multi-channel experience. In addition to improving the functional experience online, Best Buy has introduced a new metric called the Net Promoter Score (NPS) to track customer satisfaction levels with the company’s service.
     
  • Best Buy will seek to reduce costs through intelligent inventory management and supply chain optimization. Further cost reductions are planned through real estate optimization and trimming down SG&A expenses. Moreover, potential sale of Europe and China operations could fetch an additional $600 million-900 million.

Retailers’ nightmare - 1: Discounting strategy backfired

During the recession, retailers were cashing in by offering discounts to cash-strapped customers. Now, that strategy has backfired. It has bred a group of deal junkies that won't shop unless they see 70% signs or yellow clearance stickers. They're a thorn in the side of most retailers, because the discounts it takes to get them into stores eats away at profits. In fact, retailers' annual profit growth was cut in half between 2006 and last year, according to a survey of 122 merchants by research firm Retail Metrics.

So, big chains like J.C. Penney and Lowe's (NYSE: LOW) are offering sale-addicted customers “everyday low” pricing. It's the biggest shift in pricing in decades, but retailers have a long way to go to convince shoppers that predictable pricing is better than the temporary promotions that they've grown to love.

In fact, last year, nearly three-quarters of 1,000 shoppers surveyed by consumer research firm America's Research Group said they would take discounts of at least 50% to get them to buy a given item. That's up from 52% in 2005.

Retailers are to blame for the increase. To help break the vicious cycle of discounting, merchants have to think of ways to attract shoppers that can be just as intoxicating as two-hour sales or coupons. That could mean top-notch service or exclusive merchandise, for instance.

Retailers’ nightmare - 2: Price competition increased

Now, retailers are trying to replicate the success of Wal-Mart (NYSE: WMT), the world's largest retailer that was founded 50 years ago on "everyday low" prices. Experts say Wal-Mart's strategy has worked because it built its reputation on being able to offer customers the lowest prices every day.

In fact, the company's revenue at stores open at least a year in the U.S. fell for two years, when it veered away from the strategy in favor of temporary price cuts. The company has since been able to turnaround its business, in part by renewing its commitment to “everyday low” prices.

Penney executives say they considered Wal-Mart's model when they decided to change the retailer's pricing strategy. It was part of an attempt to turnaround the company, which has had annual sales declines in four of the past five years. But Penney, which has 1,000 stores, has learned that it's not so easy to duplicate Wal-Mart's magic. Customers have not embraced the new pricing.

Like Wal-Mart, Lowe's, the nation's second largest home improvement chain, built its business around "everyday low” pricing. But then, the company strayed away from that and started offering more sales when the housing market tanked in 2006. Shortly after, the company's performance began to lag behind its bigger rival Home Depot, which never veered away from its everyday pricing strategy.

Even Target (NYSE: TGT) recently made a huge move to counter the practice of “showrooming,” the term that refers to how consumers are using retail brick-and-mortar stores to go hands-on with items, which they then order online for less -- often from competitors like Wal-Mart and Amazon. The company announced that it is now extending its holiday price matching policy year-round.

It’s hard to say whether or not the move will have the desired impact. Target was price-matching online retailers over the holidays (Nov. 1 – Dec. 16), but December sales were still flat year-over-year.

Price-matching can be a dangerous game, as Best Buy found out, recently issuing complaints to the attorneys general in over half a dozen states, saying that Wal-Mart’s ads were misleading. Best Buy specifically cited an iPhone 5 price match, saying it lost $65,000 on the day of a Wal-Mart Facebook promotion, because it had to match the chain’s $150 price, despite the fact that iPhones were out of stock in many places.

The bottom line

Best Buy’s stock has doubled since the beginning of this year. Although Best Buy’s turnaround initiative has boosted investor sentiment immensely, I doubt if a sustainable turnaround is really on the cards. Given the extremely difficult environment prevailing in the retail sector as stated above, I believe only a sustainable turnaround can lift the stock even from here. 


Anindya Batabyal has no position in any stocks mentioned. The Motley Fool recommends Lowe's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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