Best Buy Talks Online Sales, Investments, and Tariffs

Consumer electronics retailer Best Buy (NYSE: BBY) beat analyst estimates when it reported its second-quarter results, and it boosted its full-year guidance to account for a strong first half. But that wasn't enough to keep investors happy. The company's third-quarter guidance wasn't quite up to snuff, and its online sales growth slowed way down. The stock dropped nearly 5% on Tuesday following the report.

The knee-jerk reaction to Best Buy's weak third-quarter guidance and slowing online sales seems overdone to me. Management took some time to discuss online sales, as well as the potential impact from tariffs and investments in the business, during the earnings call, shedding some light on what's going on with the retailer.

A mature category

Best Buy's domestic online sales grew by just 10.1% year over year in the second quarter, down from 31.2% growth in the same period last year. That's a dramatic slowdown that no doubt has investors concerned.

Best Buy CFO Corie Barry tried to explain the sluggish growth: "Regarding our online comp specifically, I would add that the consumer electronics category is a more mature online category than several other retail categories, with customer buying patterns moving online earlier than most."

That's certainly true. The percentage of the U.S. adult online buying population that made at least one consumer electronics purchase in the 12 months ending in May stands at 43%, according to NPD. Compare that to a category like groceries, which is only just beginning to shift online.

Barry believes that Best Buy still gained market share during the second quarter, despite the more sluggish online sales growth. That may be the case, but the company is certainly not winning nearly as much share as it was a year ago.

CEO Hubert Joly pointed out that the plan is to build deeper relationships with customers and extract as much total revenue as possible, whether it's online or in-store. That's part of Best Buy's 2020 strategy. Joly said that the company is still "very excited by online and all of the digital capabilities we're building for our customers." But the stores remain the core of Best Buy's business, providing a key competitive advantage that pure online retailers can't match.

Investments and tariffs

While Best Buy raised its full-year guidance, the company's third-quarter outlook fell short. Best Buy sees comparable sales growth slowing to a range of 2.5% to 3.5%, along with non-GAAP earnings per share between $0.79 and $0.84. That earnings guidance was well below the consensus analyst estimate of $0.91.

That weak earnings guidance was in part due to investments Best Buy is making in its business. Some of that spending is being offset by cost reductions -- Best Buy is aiming to weed out $600 million of annualized costs by the end of fiscal 2021. But it's not enough to prevent an impact on the bottom line.

Specialty labor related to Best Buy's services push is one source of higher costs. Services are a key part of Best Buy's growth strategy, but it will take time for the company's initiatives to pay off. The national rollout of Total Tech Support, a $199.99 annual subscription service that provides support in-store, over the phone, and online for all technology products, regardless of where or when they were purchased, will knock down gross margin by 15 to 20 basis points this year. Joly said that subscribers tend to use the services immediately, while revenue is recognized over 12 months, which puts some pressure on the bottom line.

On top of these investments, Best Buy is also anticipating a negative impact from tariffs. Joly said that the company's guidance reflects the $50 billion of tariffs on Chinese goods announced so far. Lower-margin products will see larger price increases, while higher-margin products won't be impacted as much, assuming Best Buy passes along the higher prices to consumers.

Best Buy's comparable appliance sales were up 10.3% in the second quarter, so tariffs haven't yet had much of an impact. But that could change if the trade war between the U.S. and China escalates, especially if other product categories get roped in.

All the issues affecting Best Buy's guidance are temporary. The investments in services should eventually pay off, and tariffs will (hopefully) be a short-term phenomenon. Best Buy still looks like a winner in the long run.

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