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Appliances and Services Drive Another Quarter of Growth at Best Buy

Adam Levine-Weinberg, The Motley Fool

Best Buy's (NYSE: BBY) growth has cooled in fiscal 2020, following two years of stellar gains. However, the company has continued to post positive comps, despite facing headwinds from a cyclical downturn in gaming console sales and a slowdown in the upgrade cycle for cell phones.

This growth has been driven by two of Best Buy's smaller business lines: appliances and services. Best Buy continued to post strong growth in both of those categories last quarter, allowing the company to beat its earnings guidance and raise its full-year outlook for earnings per share.

Another solid quarterly performance

In the second quarter, Best Buy's comparable store sales rose 1.6%, powered by a 1.9% increase in the domestic market. This was near the low end of management's guidance for 1.5% to 2.5% comp sales growth, largely because of weaker sales in Canada. However, this sales performance represented an improvement from the first quarter, when comp sales inched up 1.1%. Total revenue increased 1.7% to $9.54 billion last quarter, just shy of the average analyst estimate.

While Best Buy reported another quarter of relatively sluggish revenue growth in Q2, its EPS growth remained robust. The consumer electronics giant's adjusted operating margin rose to 4% from 3.8% a year earlier, thanks to strong cost control. Share repurchases and a lower tax rate also helped lift the company's adjusted EPS, which reached $1.08, up from $0.91 in the prior-year period. That beat Best Buy's guidance range of $0.95 to $1.00, as well as the analyst consensus of $0.99.

The exterior of a Best Buy store

Best Buy posted strong EPS growth last quarter. Image source: Best Buy.

Best Buy expects revenue growth to remain modest in the second half of fiscal 2020, with the wind-down of the current gaming console cycle representing a particularly significant headwind. Rising tariffs on a variety of goods that Best Buy sells could cause additional pressure. Nevertheless, the company raised its earnings guidance. It's now calling for full-year adjusted EPS between $5.60 and $5.75, up from $5.32 a year ago. The new forecast is roughly in line with analysts' expectations.

Best Buy's amazing growth in appliances continues

Appliances were the biggest driver of Best Buy's growth last quarter. Comparable sales for that merchandise category surged 14% domestically and rose 11.5% outside the United States. In fact, excluding appliances, Best Buy's domestic comparable sales would have been roughly flat.

This strong growth in appliance sales last quarter wasn't a fluke. Particularly in the U.S., Best Buy has made huge market share gains over the past decade, capitalizing on a massive downsizing at onetime market leader Sears Holdings, as well as the demise of former competitors like Circuit City and hhgregg. More recently, J.C. Penney's decision to exit the appliance market after a brief return has put additional market share up for grabs.

In fact, appliances accounted for 13% of Best Buy's domestic revenue last quarter -- more than $1.1 billion of sales volume. That's up from just 6% of its domestic revenue mix eight years earlier, or about $500 million. With Sears still on the decline, Best Buy hasn't exhausted the opportunity for market share gains yet.

Services growth should boost profitability

The other area where Best Buy is posting strong growth is in services. Comparable domestic revenue for the services category rose 10.7% last quarter, and services increased to 6% of the domestic revenue mix from 4% a year earlier.

Growing its services business has been a key strategic focus for Best Buy for the past couple of years. The company has aggressively promoted a new tech support subscription that covers all of a customer's technology products, regardless of when and where they were purchased. It also has made a series of acquisitions over the past year -- most notably, GreatCall, which provides health monitoring services for seniors.

Service revenue tends to carry higher margins than product sales. As a result, the growth of Best Buy's services business is helping the company continue its earnings momentum in the face of headwinds like rising tariffs.

Many of the headwinds weighing on Best Buy's growth should start to dissipate over the next couple of years. A new gaming console product cycle is set to begin next fall. Moreover, the ongoing trade war between the U.S. and China probably won't last forever, so tariff relief is likely at some point in the future. (Vendors are also steadily diversifying their supply chains away from China to mitigate the impact of tariffs.) If Best Buy can continue posting strong growth in appliances and services, its overall sales and earnings growth could accelerate whenever headwinds in the rest of the business ease.

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Adam Levine-Weinberg owns shares of J.C. Penney. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Appliances and Services Drive Another Quarter of Growth at Best Buy was originally published by The Motley Fool