Best Buy Inventory Levels Could Prompt Discounting, Putting Pressure on Profit Margins

January 4th, 2011 by Trefis Team
+7.30%
Upside
75.12
Market
80.61
Trefis
BBY: Best Buy logo
BBY
Best Buy

Best Buy (NYSE:BBY) is a specialty electronics retailer that competes with general retailers like  Wal-Mart (NYSE:WMT) and Costco (NASDAQ:COST) as well as other specialty retailers like GameStop (NYSE:GME) and Radio Shack (NYSE:RSH).

Our current price estimate for Best Buy’s stock stands at $38.48 which is about 10% above the market price. We estimate that Best Buy generates about 70% of its stock value from US stores.

Best Buy’s stock fell significantly after the announcement of its Q3 2010 earnings and hasn’t made much forward progress since. The primary reason was lower then expected sales stemming from the company’s misjudgment of consumer demand and competition. We’ve previously analyzed Best Buy’s product missteps following the Q3 earnings release (See: Can Best Buy Correct Product Missteps?).

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Beyond weak sales numbers, Best Buy’s product misjudgment has also led to a notable 8% increase in inventory levels at the end Q3 vs. last year. [1] Although Best Buy has rejected the idea that it will need to discount heavily to get rid of the increased inventory, the company might find itself forced to alter its stance in order to maintain market share.

Recent Market Share Loss

Retailers like Wal-Mart and Amazon are taking some of Best Buy’s consumer electronics market share with the help of promotional discounts and offers along with effective online sales strategies. Best Buy estimates that it lost approximately 1.1% market share in the 3rd quarter. [1]

Will the company need to resort to discounting in order to regain market share and reduce inventory levels?

Profit Margin Impact

Best Buy has already loosened its return policy and eliminated a 15% restocking fee on electronics. [2] It is difficult to pinpoint the potential impact of this announcement, but it will likely lead to increased returns, greater restocking, and consequently additional inventory. As inventory levels become further bloated, Best Buy may be forced to start dropping prices. Any such move would pressure company profit margins, although we note that the long-term impact is limited.

From a long-term perspective, we remain bullish on Best Buy. We believe that the company will able to rectify its inventory concerns, although uncertainties surrounding pricing and product inventory might cause investors to remain cautious, maintaining near-term pricing pressure on the company’s stock.

See our full company breakdown and estimates for key drivers to Best Buy’s stock value in the display below.

You can see the complete 38.48 Trefis price estimate for Best Buy’s stock here.

Notes:
  1. Best Buy’s Sales Suffer as Shoppers Chase Deals, Wall Street Journal, 14th Dec 2010 [↩] [↩]
  2. It’s Easier to Return Those Unwanted Gifts, The Wall Street Journal, Jan 2 2011 [↩]