Best Buy Could Be In For A Tough Holiday Season As Competition Rises
The 2015 holiday season is just around the corner and retailers are gearing up for it. In the past year or so, brick-and-mortar retailers have been reinventing their business models to get back in the race against online rivals. As they are better positioned to compete with e-commerce players now, the level of competition has significantly increased compared to that during the holiday seasons in the past.
While retail sales in the US this year have been growing at a slower pace than they did before, product cycles in mobile phones and launches of other gadgets are likely to boost sales a bit. But, it won’t be an easy task for retailers to win those sales given the escalated competition driven by price match guarantees from multiple retailers. As a result, we expect profit margins to see a larger decline this time around.
Below, we take a closer look at the factors that are likely to impact Best Buy‘s (NYSE:BBY) sales and margins in the upcoming two-month period and, eventually, their impact on its stock price. Our price estimate for Best Buy stands at $36, slightly above the current market price.
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See our full analysis for Best Buy
Product Launches Will Provide Support To Slowing Sales
Manufacturers usually come up with upgraded versions of their products ahead of the holiday season. For example, leading mobile phone manufacturers including Apple, Google and Samsung have all released newer versions of their flagship mobile phones in the last few months. However, with advancements in technology and emergence of wearable gadgets, average pricing in popular product lines has been on a rise, which could provide a boost to overall spending. According to consultancy firm AlixPartners, sales are expected to grow between 2.8 percent and 3.4 percent during this year’s shopping period [1].
New products, for example, Apple Watch, are also likely to contribute in a significant manner to top line growth. Earlier in August, Best Buy became the first non-Apple store to officially sell the product, followed by Target (NYSE:TGT). It is estimated that around 2.3 million Watch units were shipped in the second quarter of 2015, according to BMO capital markets, with revenues estimated at approximately $1 billion by Juniper Research [2]. While Target has also promised to make Apple Watches available in all its stores by late-October, we believe Best Buy is likely to attract a larger shopping crowd because of its store-within-a-store format, which offers a better customer experience than a typical store environment.
Impact On Margins Will Be More Severe
Best Buy’s price match guarantee was a key part of the company’s turnaround strategy, Renew Blue, which also helped draw customers during periods like the holiday season. A year ago, Best Buy’s gross margin during the Nov-Jan period was 21.8%, 60 basis points lower than the annual 2014 average. But, the company was able to more than compensate for the lower gross profits by reducing operating costs and driving supply chain efficiencies [3]. During the same period, operating margin was higher than the annual average by 270 basis points at 6.3%. However, things will be a little different this time around.
Price competition has gotten more intense with competitors Target and WalMart (NYSE:WMT) introducing their own price matching policies. With retail sales growth being weaker than that in 2014, retailers will likely be fighting for a smaller amount of incremental sales, leading to a more severe pricing environment. Moreover, Best Buy now has fewer opportunities for cost reduction, which leaves its bottom line more exposed to changes in gross margin.
While we have built in a certain level of margin decline into our model, a larger-than-expected decline could negatively impact Best Buy’s valuation. Per our forecast, Best Buy’s gross margin is expected to decline from the current level of 21.4% to 20% by 2017 and then to 18% by the end of our forecast period. Using the Trefis widget below, one can assess the impact of different-than-expected gross margins on Best Buy’s stock price.
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