Best Buy Gets Hit by Spending Slump

Investors flee after the retailer's executives say they don't know how gloomy this holiday season will be

By Ben Steverman

Best Buy (BBY) terrified investors on Nov. 12 with bad news indeed. The electronics retailer said it sees consumers sharply cutting back their spending. Even worse, the well-respected executives at Best Buy seem to have little idea how bad conditions could get this holiday season.

"Since mid-September, rapid, seismic changes in consumer behavior have created the most difficult climate we've ever seen," Best Buy Chief Executive Brad Anderson said in a statement. "In 42 years of retailing, we've never seen such difficult times for the consumer," added Brian Dunn, Best Buy's chief operating officer and president. "People are making dramatic changes in how much they spend, and we're not immune from those forces."

Those fearful quotes stirred concern in the stock market because, on balance, Best Buy is seen as one of the strongest players in the retail industry. A chief rival, Circuit City (CC), filed for bankruptcy protection on Nov. 10, while another rival, Tweeter, is shutting all its stores. Best Buy, meanwhile, is gaining market share and appears to have plenty of cash to keep expanding even during a nasty recession.

Reducing Its Guidance

Still, the statistics don't look good even for Best Buy. The retailer cut earnings-per-share expectations for fiscal 2009 on Nov. 11 from a range of $3.25 to $3.40 to a wider range of $2.30 to $2.90.

Driving Best Buy executives' pessimism is a scarcity of customers buying electronics. Same-store sales, those at stores open a year or more, fell 7.6% in October, but this could be just the beginning. The company expects same-store sales in the next four months—November to February—could fall as little as 5% or plunge as much as 15% from the year before. Best Buy shares fell 8% on Nov. 12 to close at 21.97. Its stock is down 58% this year.

The magnitude of the revisions to earnings and sales estimates was surprising to many analysts and investors, but even more surprising were the wide ranges of Best Buy's estimates. "There is just no visibility," says Terry Morris, senior equity manager at National Penn Investors Trust Co. "These retailers don't know what to expect."

Consumers Worried About Income

Morningstar (MORN) analyst Brady Lemos points out that "this is a different environment" than anyone is used to, demonstrated by Anderson's comment that this is "the most difficult climate we've ever seen." Previous recessions are little guide to executives and investors now, Lemos says. "It's not the typical six-to-nine-month slowdown," he says.

With unemployment rising, consumers are worried about their income potential, says Scott Tilghman, an analyst at Hudson Square Research-Soleil Securities. With credit-card firms and banks cutting back on credit, consumers can't simply borrow, he adds. And falling home prices and a plunging stock market have Americans worried about their overall net worth.

Best Buy's "performance tells us the scope of this recession is impacting mid- to higher-income families faster than most anticipated," wrote Raymond James (RJF) analyst Dan Wewer on Nov. 12.

Expanding Market Share

There are some advantages for Best Buy: It's in a stronger financial position than rivals, with Tilghman estimating the firm will generate about $600 million in free cash flow in fiscal 2009 even if earnings are at the midpoint of the firm's new, lower estimate range. And in the long run, the troubles at Circuit City, as well as the strains on several regional electronics chains, should help Best Buy expand market share.

But in the short term, many wonder if retailers are setting themselves up for a massive price war that will wipe out profits this holiday season. Closing stores may be liquidating merchandise just as their rivals, stuck with just too much holiday inventory, are also slashing prices. "Best Buy does have a great track record," says Morris. "If they're having tough times, what's going to happen to companies that aren't as financially sound?"

Much depends on how many consumers show up ready to shop for bargains from Thanksgiving to Christmas. And, here, retailers like Best Buy are flying blind. "No one knows what next week will bring," says Tilghman, much less the entire holiday season or next year.

Eventually, the retail sector will recover, and many analysts bet that Best Buy will prosper in a post-recession landscape. But no one knows how long consumers' wary mood will last. Another important question is how much the slowdown and credit crunch are permanently altering Americans' appetite for TVs, phones, computers, video games, and other pricey gadgets.

Steverman is a reporter for BusinessWeek's Investing channel.