Can Electronics Retailers Reconnect?


It'll be hard to find a hotter-selling bunch of products in 2003 than such digital toys as DVD players, digital cameras, MP3 players, and flat-panel TVs. The Consumer Electronics Assn. expects unit sales of those and other such gizmos to rise by double digits. That may not mean gangbuster results for electronics retailers, however, because a lackluster economy and intense competition will keep pressure on prices and profit margins.

Indeed, the industry's dollar sales will rise only about 3.5%, to $99.5 billion, predicts the CSA. That's a little worse than 2002's modest increase of 3.7%. "It's a pretty promotional environment, and it's worse in discretionary sectors," says Colin McGranahan, an analyst at Bernstein Research in New York City. "People will buy toilet paper, but they don't need a $1,200 TV."

For investors, that means one thing: Be cautious when buying shares of electronics retailers. Sales over the holidays just past rose at a slower rate than in the year before, estimates McGranahan. Consequently, most analysts fear that earnings in the first half of 2003 will look weak compared to the profits in the first half of last year. Not until the last half of the year, they say, will earnings and stock prices rebound -- and that depends on the economy getting stronger.

WEAK SPOTS. On top of that, each of the major electronics retailers is dealing with issues of its own. Shares of No. 1 retailer Best Buy (BBY) may be the safest bet, since it continues to pad its approximately 20% market share by winning sales from weaker players. Still, its money-losing Musicland music chain could limit the stock's upside. Best Buy's closest competitor, Circuit City (CC), is struggling to boost its roughly 10% share of the business and may need to if its stock is to advance from its current 52-week low.

RadioShack (RSH) recently confirmed guidance of 13% to 15% annual earnings-per-share growth over the next three years, thanks to a push from a planned stock repurchase program. But skeptics say it has to prove it can follow through, after weak results over the last two years. And high-end stores, such as Tweeter (TWTR) and Ultimate Electronics (ULTE), badly need an improvement in consumer spending to lift sales and profits.

For now, Best Buy remains the top performer of the lot, with earnings and sales gains in each of the past five years. It plans to add 60 new stores in 2003 to its base of 500. Still, Best Buy locations, which accounted for about 90% of the $20.4 billion in revenues, recorded only a 2.1% increase in December same-store sales, vs. a 6.2% gain the year before. It's fortunate that Musicland is only about 10% of Best Buy's total business, as that unit's December sales plunged 14.7%.

"ONLY STOCK TO OWN"? Best Buy recently said it will close 110 out of its 1,200 Musicland stores. But either devising a viable strategy or gradually shuttering the remaining stores will take years. "That clouds the story for investors," says Joseph Beaulieu, an analyst at Morningstar. He pegs the fair value of Best Buy's stock at $30 (it was trading around $27 as of Jan. 21).

Nonetheless, "Best Buy is the only stock to own among consumer-electronics retailers," says James Ragan, an analyst at Crowell, Weedon & Co. in Los Angeles. Both analysts agree that the shares, which hit a 52-week high of $53 in March, would look more attractive in the low-$20 range. Ragan says his firm has no investment-banking ties with Best Buy, and he doesn't personally own shares.

At Circuit City, the mission is to recover from many missteps over the past several years. In early 2002, for instance, its profits fell short of expectations because of extra-tight inventories -- it ran out of popular products. Its margins also have been consistently narrower than Best Buy's. In its fiscal year ended in February, 2002, Circuit City's operating margins were 2.2%, better than the 1.8% of the previous year but far short of Best Buy's 5.2% in the same period. Now, Circuit City is remodeling its stores and focusing on better product selection to boost sales per square foot.

BITS AND BOBS. While Circuit City doesn't come close to Best Buy's track record, many analysts think its stock, trading around $7 as of Jan. 21, could be a better value. "It's really cheap, and the downside is limited since the company has significant excess cash," says Bernstein's McGranahan, citing the $438 million on hand at the end of November. McGranahan doesn't own shares in either company, and Bernstein doesn't perform investment-banking services, though its parent asset-management company, Alliance Capital, may at any time hold positions in stocks he covers.

Beaulieu figures Circuit City's stock would be fairly valued at $11 per share, but to reach that price the company would have to deliver mid-single-digit revenue growth plus small improvements in margins, he says. "If they could get their operating metrics to look more like Best Buy's, the stock could be worth in the upper teens or even $20," he adds. Beaulieu doesn't own shares in any of the consumer-electronics companies he covers, and Morningstar doesn't perform investment banking.

RadioShack, which has nearly 5,300 stores, also has been trying to fashion a comeback since its profits peaked in 2000, thanks to sales of wireless phones and services. Adding more stores doesn't make sense, so it has been cutting costs and focusing on selling more of the bits and bobs that go with electronics gadgets. Despite Radio Shack's predictions to the contrary, analysts worry that its long-term growth rate won't be stellar. Beaulieu notes that since 1997, it has had just one year of positive revenue growth. He puts the stock's fair value at $23, vs. the $22 range at which it was trading on Jan. 21.

ALL-IN-ONE BLUES. More than the other chains, high-end retailers need a significant bounce in discretionary spending before their stocks can take off again. Indeed, holiday sales at Tweeter and Ultimate Electronics fell more than 50% short of analysts' expectations.

Tweeter, based in Canton, Mass., has also said that its results have fallen short of levels required by a loan held by FleetBoston Financial Group (FBF) -- and that it's trying to renegotiate the terms. Thus the stock, though cheap at around $4 per share as of Jan. 21, is a risky bet. Ultimate, which plans to add eight stores this year to its base of 46 in the Midwest, is better off. But its stock remains depressed at around $9, well off its 52-week high of $32. Some analysts say the shares are worth considering at this price since the retailer has plenty of store growth left.

A decline in sales of home-audio products is a particular problem for high-end retailers. Steve Wood, vice-president for merchandising at Ultimate, explains that many customers are now buying complete home-theater systems -- prepackaged collections of several audio components. "This pulls down the average selling price" of components, Wood says. All-in-one systems cost anywhere from $149 to $2,500, but most people buy something in the $200 to $600 range. For companies like Ultimate and Tweeter, that sale would have been closer to $1,000 in the past, when the components were sold separately.

DISCOUNT PERIL. Competition will also keep electronics retailers on their toes. Department store Sears Roebuck (S) has always had sold consumer electronics -- but now it's beginning to aggressively expand its selection. And discount giant Wal-Mart (WMT) and warehouse club Costco (COST) keep nibbling away at the pie. Discounters "are a risk to margins," says Ragan. "They don't have the [selection] on the floor, but they will get their fair share of sales."

Electronics retailers have clear marching orders for 2003: Solve the problems that are specific to them, maintain strict cost discipline -- and hope that a reviving economy plus consumer enthusiasm for new products deliver a pleasant surprise in the second half. By Amy Tsao in New York


Best LBO Ever
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus