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On Tuesday, electronics retailer Best Buy (BBY) released third-quarter results, topping the Street's forecast along with raising guidance for the current fourth quarter. As a result, the stock fell more than 8%. Wait, what? Best Buy crushed the Street's estimate, reporting earnings of 53 cents per share when 43 cents per share was expected; reported increased sales of $12.02 billion, topping expectations for $11.98 billion; and upped its full-year earnings and revenue guidance to a range of $49 billion to $49.5 billion from $48 billion to $49 billion -- so why did the stock plunge? Best Buy executives noted that profit margins would fall, thanks to shoppers buying more low-margin items like "cheap notebook computers and entry-level flat panel digital TVs." This strategy bothers some analysts, as Anthony Chukumba with FTN Equity Capital Markets noted that, "Best Buy is managing its business for gross margin dollars not the gross margin rate."
Basically, lower margin products will not bring in gross margin dollars. The company faces a great deal of competition for these lower margin products from the likes of Target (TGT) and Wal-Mart (WMT), where products like entry-level televisions are less expensive. If Best Buy is relying on these items to pull the company higher, it may be a bit of a miscalculation.
This belief was reinforced by Societe Generale, which cut Best Buy to sell from buy. The reason for the downgrade is that the earnings beat is of "low quality" -- the result a one-off tax settlement. Societe Generale added that Best Buy's product mix puts the company's gross margin under pressure.
Technically, shares of the electronics retailer may find a bit of support from its 10-month moving average. This trendline has taken a northward trajectory, passing through the $39 region. We could see the equity pull back to this level and regroup after the earnings report and the subsequent downgrade. It also seems that BBY's 10-week moving average is going to provide support, but this morning's downgrade may be a bit more than this trendline can handle. That said, the 10-week trendlne has acted as support since the end of March. Unfortunately, the stock is in a difficult situation following the earnings report.
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