Can Bricks And Mortar Fight Back?

Investor's Business Daily

The long-anticipated launch of two new video gaming consoles planned just ahead of the holiday shopping season has pushed electronics retailers GameStop (GME) and Best Buy (BBY) into what one analyst has dubbed "the calm before the console storm.

Sony (SNE) is scheduled to release its PlayStation 4 on Nov. 15, followed by Microsoft's (MSFT) Xbox One on Nov. 22. It's been eight years since Microsoft launched a new console, and seven years since PlayStation 3.

Enthusiasm for those computer gaming units, along with the number of new games, is growing, according to Baird Research analyst Colin Sebastian.

"As such, we remain cautiously optimistic on the sector ahead of the fall platform launches," says Sebastian.

Investors have driven Best Buy's share price up more than 250% and GameStop ahead 105% so far this year. But caution is still the prevailing tone among analysts.

As a group, electronics retailers continue to wrestle through a years-long transition. The industry has worked to build e-commerce businesses alongside their brick-and-mortar stores in order to battle online challengers such as Amazon.com (AMZN) . The strictly online competitors don't shoulder the overhead of traditional chains, allowing the newer e-commerce group to undercut existing chains on price.

The result was a shakeout, with the electronics retail field losing nearly 700 stores in a series of failures led by Circuit City, which shut its doors in 2009, but also included regional players such as Massachusetts-based Tweeter and California's Good Guys. Best Buy, GameStop and a few others survived. At least a few members of the consumer electronics group are narrowing the price gap with e-commerce competitors, and now seem to be on the verge of growth.

IBD's consumer electronics industry group includes six companies. Best Buy, with a market capitalization of $14.62 billion and revenue expected to clear $46.2 billion this year, is the largest. GameStop, with more than 6,600 stores worldwide, and RadioShack (RSH), with almost 5,600 stores, have the largest footprints.

Collectively, the stocks have gained 133% year-to-date, holding the group in a steady top 20 ranking since April among the 197 industries tracked by IBD.

Going Toe-To-Toe On Prices

Richfield, Minn.-based Best Buy in particular has made it its mission to match Amazon.com and other e-commerce sites on prices, according to BB&T Capital Markets analysts Anthony Chukumba and Eric Cohen.

"With the notable exception of accessories, Best Buy's prices are largely in line with those of Amazon, and in some cases were actually lower," wrote the analysts in a recent research note.

But if you include accessories — like, say, a smartphone case or a USB cable — in the comparison, Best Buy's prices in September were an average of 3.7% higher than Amazon's. That was down, however, from a 4.4% premium in May, wrote BB&T's analysts, who rate the stock a buy with a price target set at 45.

Surely, the fight between retailers to have the lowest prices has its drawbacks.

Best Buy's management is "resolute in its determination" to compete on price, says Wedbush Equity Research analyst Michael Pachter, who rates the stock as underperform, or sell. Best Buy's efforts have cut into its profit margin, that analyst says.

"We see no end in sight and expect price competition at holiday . .. to erode margins further," says Pachter.

Best Buy's EPS rank, as calculated by IBD, is just 46 out of a possible 99.

The group collectively shows a lack of revenue growth, with each company in the group this year expected to post flat or declining revenue, according to analysts polled by Thomson Reuters.

The South Rises

The exception is Beaumont, Texas-based electronics chain Conn's (CONN), which is seen growing sales. Conn's is expected to grow its revenue by 34% to $1.16 billion, according to eight analysts polled by Reuters. All eight analysts rate the stock as a buy or equivalent.

With 70 stores spread through Texas, Louisiana, Oklahoma, New Mexico and Arizona, Conn's has a relatively small footprint compared with 1,055 U.S. Best Buy stores and 6,505 GameStop-owned stores.

It sells consumer durables such as appliances and furniture, along with electronics. And, unlike the other group members, Conn's attracts some customers with "subprime" credit with its rent-to-own market — and that's one area where it could grow in the future, according to Piper Jaffray analyst Peter Keith.

"In short, Conn's has a supremely attractive growth opportunity over many years due to a very limited market share today — we estimate 1% — and no clear competitive threats on the horizon," says Keith.

Same-store sales at Conn's climbed 18.4% in Q2, bucking another trend in the electronic retail group. Best Buy's same-store sales have fallen in each of the last 12 quarters. Year-over-year same-store sales declines have accelerated each of the last three years.

But Best Buy's trend could be turning around, says ITG Investment Research analyst John Tomlinson in an email. He sees the chain's current-quarter same-store sales growing from 3% to 5%, in part because the company's managed to sell more items priced over $1,000.

Best Buy's executives say they're taking a three-pronged approach to jump-starting sales. First is returning to online-sales growth. Second is "accelerating the multichannel customer experience," which is a way of saying that they're monitoring how customers shop and polling them after sales. Third is an attempt to boost sales per foot.

As a result, online sales growth already has started picking up, says President and CEO Hubert Joly.

"Including all of these initiatives, our domestic online channel delivered a 10.5% comparable-store-sales increase in the quarter," Joly told analysts on a fiscal Q2 conference call.

An Ode To Joysticks

The effort to boost sales at Best Buy and its competitors no doubt includes gaming console sales, which are a big business in the U.S. Both Sony's and Microsoft's gaming consoles are now in preorders.

"Including these preorders, which we do not expect to ship or recognize as revenue until Q4 of fiscal 2014, comparable online demand increased over 16% (in Q3)," said Joly.

Grapevine, Texas-headquartered GameStop says manufacturers are better prepared to deliver this year, as well.

"Allocations from both Microsoft and Sony are much stronger than last launch," GameStop President Tony Bartel has said.

Bartel said was unable to disclose launch quantities for competitive reasons. But said he expects a "significant increase in launch-day quantities vs. the last console launch.

Sterne Agee analyst Arvind Bhatia says in a research note that everything he's seen continues "to suggest strong demand" for the new consoles.

Those two new gaming consoles should boost revenue late this year, but there's another game that's already having an affect on GameStop's sales, according to SunTrust Robinson Humphrey analyst David Magee. "Grand Theft Auto 5," which went on sale Sept. 15, posted $800 million in global sales on its first day on the market.

Before the launch, Magee had expected the game to add profit of 8 cents per share in Q3 for GameStop. "However, given the success on the first day of sales, we believe this is most likely conservative," the analyst wrote, adding that the game could add "several pennies" to GameStop's per-share profit in the current quarter.

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