Silver lining for Best Buy despite drop in income

Best Buy improved market share and grew sales at a healthy clip, but spent more to do it than analysts had expected.

Now going into the second half of the year, when it rings up 70 percent of its sales, the Richfield-based retailer is expecting consumer spending to slow slightly.

Best Buy on Tuesday reported a 19 percent drop in second-quarter net income to $202 million, or 48 cents a share. Revenue rose 12 percent to $9.8 billion on the strength of notebook computers, video games, flat-panel televisions and improved mobile phone sales.

The company said it missed analysts' earnings expectations by 9 cents a share because of higher-than-expected expenses during the quarter, including building mobile phone stores within Best Buy stores. It was the first time the company had missed earnings expectations in five quarters. For the past year, it has beaten quarterly expectations.

"Most analysts are pretty concerned" about the impact of a deteriorating economy on Best Buy, said Mitchell Kaiser, a Piper Jaffray analyst in Minneapolis. "If Christmas doesn't come, Best Buy will suffer."

During a company conference call, some analysts also asked about sales of flat-screen televisions this holiday season. They wondered if an oversupply of LCD and plasma TVs could force Best Buy to cut prices, thus making its financial goals harder to achieve.

"Manufacturers have scaled back on TV production, but there is too much supply right now," Kaiser said.

Because Best Buy said second-quarter revenue and gross profit were in line with its goals, some industry analysts argue that although the economy is not favorable, consumers have continued to buy electronics.

"I'd be much more concerned about Best Buy and the consumer electronics industry if they were not making their sales numbers," said Stephen Baker, an analyst at retails sales tracking firm NPD Group of Port Washington, N.Y. "This tells me that people are still out there spending."

Same-store sales, considered a good barometer of a retailer's health, grew 4.2 percent during the quarter and even more -- 5.3 percent -- at U.S. stores. Sales in China, considered a big growth market for Best Buy, fell 7 percent, which the company blamed on the country's poor economy.

Best Buy is maintaining earlier guidance that annual earnings will be in the range of $3.25 to $3.40 a share, an average increase of about 7 percent from last year, even as consumer spending softens the rest of the year.

One of Best Buy's big advantages is its claim of having a nearly 21 percent domestic market share in consumer electronics in the second quarter, up 1.6 percent from a year ago. Analysts believe it has been taking market share from Circuit City, which is struggling.

"We continue to grow our business faster than just about anyone in this space," said Brian Dunn, Best Buy's chief operating officer. "And our internal measures of customers satisfaction have hit a new high, over 81 percent."

Best Buy stock closed at $42.40 Tuesday, down about 3 percent to $1.30. Earlier in the day, the stock had been down nearly 10 percent before recovering somewhat alongside broader market gains.

Best Buy promised to cut expenses, but analysts said it was unclear how that would affect future sales, particularly if sales jobs were to be eliminated.

"Some of those expenses helped drive revenue," Kaiser said. "The question is whether they can cut expenses and not hinder the top line."

Best Buy said it would not cut its major sales initiatives, such as its effort to improve mobile phone sales by adding more sales people who can spend more time helping customers make buying decisions.

Cellular phones are seen as a higher-profit product at a time when profits on consumer electronics standbys, such as computers and video games, have been shrinking for about two years, analysts said. Best Buy receives a payment from cell phone service providers, such as AT&T, for signing new customers.

Another new initiative is Best Buy's announcement this week that it would acquire online digital music provider Napster for $121 million.

Steve Alexander • 612-673-4553