Investors didn't seem to like Best Buy's (NYSE: BBY) latest quarterly report. The stock sank on Thursday despite the consumer electronics retailer beating analyst expectations across the board. Comparable sales surged, driven by strong demand for mobile phones, appliances, computing, and smart-home products. And the bottom line rocketed higher, aided by a lower tax rate.
To be fair, Best Buy's report wasn't all peaches and cream. Online sales growth slowed down, and the company's margins took a hit. Best Buy also left its full-year guidance unchanged despite the stronger-than-expected first quarter. Best Buy tends to be conservative with its guidance, but investors were clearly looking for more.
What went right
Best Buy produced $9.1 billion of revenue in the first quarter, up 6.8% year over year. Comparable sales surged 7.1% overall, with 7.1% growth in the domestic business and 6.4% growth in the international business. The company managed just 1.6% comparable sales growth in the first quarter of last year.
CEO Hubert Joly pointed to healthy consumer confidence, product innovation, and the company's unique value proposition as the main drivers of the robust sales growth. Best Buy is operating in "an opportunity-rich environment," the result of technology innovation and customers' need for help. The company is capitalizing by increasingly offering solutions, not just products.
In the domestic business, which accounts for the vast majority of revenue, most product categories produced growth in the quarter. Appliances were the standout, with computing and mobile phones not too far behind.
The bottom line grew even faster than revenue, with non-GAAP earnings per share surging 37% to $0.82. Best Buy's effective tax rate was just 19.2% during the quarter, down from 35.6% in the prior-year period. That tax cut, courtesy of the U.S. tax reform bill passed late last year, was responsible for Best Buy's earnings growth. Share buybacks boosted per-share earnings even further.
What went wrong
The lower tax rate allowed Best Buy to report solid earnings growth despite a slump in its gross margin. Gross margin dropped 0.4 percentage points to 23.3% during the first quarter, the result of rate pressure in the mobile phones business as well as prior-year legal settlement proceeds related to the services business. This gross margin decline was enough to send GAAP operating income down 11.7% year over year.
Another issue with Best Buy's report was its online business. Domestic online sales grew by just 12% year over year, accounting for 13.6% of total revenue. That's down from 22.5% growth in the prior-year period. Higher average order values and higher conversion rates pushed up online sales, but not enough to match last year's performance.
The good news is that Best Buy believes this slowdown was mostly due to the timing of product launches. Both the Nintendo Switch and Samsung Galaxy S8 launched in the first quarter of last year, so Best Buy lapped those launches in the first quarter of this year. Best Buy is still gaining online market share, according to CFO Corie Barry, and the number of customers ordering online and picking up in store is on the rise.
Lastly, Best Buy maintained its full-year guidance, calling for comparable-sales growth between 0% and 2%, and non-GAAP EPS growth between 9% and 13%. With such a strong first quarter, Best Buy is either being conservative, or a significant slowdown is coming in the second half of the year.
More good than bad
There's no reason to panic over Best Buy's report. Margins were down, but the company expects its adjusted operating margin to be essentially flat this year, even as it makes investments in its services business. Revenue growth will almost certainly slow down later this year, but the company has long-term growth opportunities in services, smart home products, appliances, and its international business.
Another reason to not worry: Best Buy's balance sheet remains rock-solid, with about $1.3 billion of net cash. This gives Best Buy the resources to make growth investments and the ability to weather any downturns in the future. Best Buy is one of the few large retailers that isn't saddled with a ton of debt.
While the market wasn't thrilled with Best Buy's numbers, shareholders should be mostly happy with the results.
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