Best Buy: Should You Buy After the Plunge?

One of this year's biggest success stories has been Best Buy's  turnaround, which has sent the stock on a meteoric rise and made it one of the best performing stocks of the S&P. Perhaps this is why the company's latest earnings report came as something of a surprise to the market. The company's revenue miss had retail investors worried, as increased competition from the likes of Wal-Mart Stores and Target especially forced Best Buy into increasing its promotions.

Revenue flat, comps uninspiring
On the face of things, Best Buy's third-quarter report wasn't too bad. Earnings per share of $0.18 easily beat the $0.12 consensus estimate, and were up substantially from the $0.04 earned a year ago. On the other hand, the comparison is an easy one as last year's earnings were fairly dismal. It wasn't so much the earnings that bothered investors, but rather the company's flat revenue growth and soft fourth- quarter guidance.

Total revenue dipped 0.2% to around $9.36 billion. Analysts were looking for revenue of around $9.37 billion. Comp sales were up only 0.3%, although this was considerably better than last year's 5.1% drop. While these numbers aren't too bad, weak holiday season guidance sent the stock plunging.

Best Buy shareholders shouldn't complain too much though with the stock up around 226% year-to-date. Despite this impressive performance, the stock still trades at only 13.9 times forward earnings.

While management seemed quite pleased with its third-quarter top-line results, the company warned about its Q4 gross margin. As a result of pressure from competitors, Best Buy will have to maintain and perhaps even step up its promotional efforts, which is now seen impacting the margin slightly more than previously expected. The negative gross margin impact is now seen at 60 to 70 basis points versus a previous 40-70 basis points. Investors were clearly not amused.

Best Buy is still committed to its price-matching policy, with the company "highly aware" of the pricing pressure competitors will be coming up with for the holiday season. Nevertheless, analysts seem confident in the company's ability to control costs and grow the top line. As such, Q4 results may turn out to be not as bad as some fear.

Pricing pressure mounting
Ahead of the holiday season, which according to many will be a tough one for retailers, companies are aggressively lowering prices. Wal-Mart is somewhat jumping the gun this year, starting price cuts a full week before the Black Friday insanity. Also, like Best Buy, it will be opening at 6 p.m. on Thanksgiving night. The company itself is optimistic going into the holiday season, expecting its low-price policy to pay off.

Target is another company expected to suffer from Wal-Mart's pricing power. The retailer will be opening its store at 8 p.m. on Thanksgiving night, and like the competition, is working on a range of savings and deals. Throughout the company's Cyberweek sales, around 100,000 items will be marked down.

Shopper's using Target's REDcard get an additional 5% discount on most products during the week. Basically, most retailers will be feeling the pinch from promotional spending, with Wal-Mart's enormous pricing power a threat to other big names.

The bottom line
Investors weren't too pleased with Best Buy's Q3 report, as flat revenue and uninspiring Q4 guidance weighed on the company's stock price. Pricing initiatives from Wal-Mart especially will keep Best Buy spending money on promotions, a factor which will also affect competitor Target. On the other hand, the stock is still trading at a very reasonable multiple despite an incredible rise in stock price this year, and the company may have some surprises in store for its holiday earnings report.