Time to Make a Choice Best Buy

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

Best Buy (NYSE: BBY) has been the subject of many articles suggesting that the company has become the primary show room for Amazon.com (NASDAQ: AMZN). I've written in the past that the steps the company is taking to move towards being more of a mobile phone, tablet, and appliance sales center were the right ones. However, it seems the company needs to go ahead and make a decision about where their strengths lie and then move quickly to eliminate their weaknesses and capitalize on their opportunities. This was made perfectly clear in Best Buy's most recent earnings report.

With revenue down 3%, same-store sales down 3.2%, and diluted EPS from continuing operations down 49%, there is no question Best Buy needs to do something different. Though the company does have international operations, the fate of Best Buy will rest primarily in their United States division. With the U.S. representing almost 74% of total revenue and nearly the same amount of gross profit, hard choices need to be made if the company is to survive and prosper. The easiest way to determine what the company should be focused on is, to look at where the strengths and weaknesses are in their current product mix. The numbers are fairly clear in showing what customers believe Best Buy does well. Take a look at the company's comparable sales in each of their divisions, and I think you'll see which ones should stay and which ones should go.

<table> <tbody> <tr> <td> <p><strong>Strengths</strong></p> </td> <td> <p><strong>Weaknesses</strong></p> </td> </tr> <tr> <td> <p>Computing and Mobile Phones – up 8.2%</p> </td> <td> <p>Consumer Electronics – down 9.6%</p> </td> </tr> <tr> <td> <p>Appliances – up 9%</p> </td> <td> <p>Entertainment – down 22.1%</p> </td> </tr> <tr> <td> <p>Services up 1.2%</p> </td> <td> <p>  </p> </td> </tr> </tbody> </table>

The solution is obvious; Best Buy needs to move a lot of its inventory out the door never to return. The company's recent announcement that they would close 50 big box stores and replace them with about 100 smaller format stores is a step in the right direction. The single strongest category for the company was their mobile phone division which saw comparable store sales growth of 35% in the current quarter. Given that computing and mobile phones represent 44% of revenue, this division should stay, but the company needs to rethink the way that it sells computers. It's not really a question of displaying a large number of computers for customers to choose from. What would be more effective is display the most popular models, and offer alternative options through the company's online channel. This would allow Best Buy to carry less inventory in the physical stores, and yet maintain their sales growth in this division. As proof that customers enjoy Best Buy's online shopping experience, consider that domestic online revenue jumped 14%. The company's continued strength in appliance sales comes as somewhat of a surprise, yet this has been ongoing. This is a credit to Best Buy stocking the correct type of inventory rather than a huge amount. It's no surprise that services revenue increased, as the company's Geek Squad is well known. While the company may not believe it, consumer electronics and entertainment sales may never be the same at their big box stores.

The concept of show rooming says that consumers come into a physical location like Best Buy to check out the merchandise, and then go online to a website like Amazon to make the purchase. Amazon's own sales bear this out, as the company's growth in consumer electronics and general merchandise was 38.46% last quarter. In addition, this is becoming an even bigger portion of Amazon sales and has increased from 62% of total revenue to 66% in the last quarter. Sometimes it's better for a retailer to understand that they can't win at a certain game, rather than to continue losing to try and prove a point. In addition, companies like Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) are stealing electronics sales from Best Buy because of their expanded collection and customers more frequent visits. The simple truth is, customers go to Wal-Mart and Target on a much more frequent basis than they visit Best Buy. This is because both of these companies have dramatically expanded their grocery and household offerings to compete more directly with traditional grocery stores. Customers are much more likely to pick up an electronics item as an additional purchase, at either of these two retailers rather than make a separate trip to Best Buy. The bottom line is, Best Buy is losing business in certain categories and needs to accept these losses rather than continuing to compete where they are not effective. What the company can do is improve their selection in their stronger areas, and use their financial strength to their advantage.

Best Buy is already doing as much as possible to reward shareholders. In the last year, the company retired over 12% of their diluted share count. In addition, the company decreased its big-box square feet while increasing revenue per square foot. I would suggest this is the future of Best Buy, a smaller company with many locations selling a more focused product line. In the meantime, the company is still generating positive free cash flow, producing nearly $300 million in the current quarter. While Best Buy did withdraw earnings guidance, the company still forecast free cash flow between $1.25 billion and $1.5 billion. The company has time to work out its strategy, but the company must realize that the longer it delays making these hard choices, the more difficult the transition will be. Best Buy needs to play to its strengths and eliminate its weaknesses. In short it's time for the company to make a choice.

MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Best Buy. Motley Fool newsletter services recommend Amazon.com. 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.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus