In discussing the retail sector, I'm constantly reminded of Einstein's classic definition of insanity: doing the same thing over and over expecting different results.
This is especially applicable to consumer-electronics retailers. Historically, many of the names were typically regional players (The Wiz, Rex, CAMPO, Crazy Eddie are just a few examples). Some grew to national reach such as Circuit City, Best Buy (NYSE: BBY), or H.H. Gregg (NYSE: HGG). But many of them are now dead and gone, including Circuit City.
What did all of these retailers have in common? They all essentially had the same business model -- brick-and-mortar retail stores focused on electronics. And now, Best Buy, the biggest electronic retailer and one of the biggest of all the big box retailers, is finally starting to show chinks in its armor.
Here are three reasons why it may make sense to sell (or short) the stock.
1. Negative December comps
Overall, holiday sales were down 0.4% over comparable sales for the same period last year. While this isn't a huge miss, it's a miss for the most important season of the retail year. In addition to the disappointing sales numbers, in-store traffic was lower than expected. This is a glaring concern because the company made a decision to discount aggressively in some segments.
International sales were also off significantly: down 4.3% compared with analyst expectations 1% losses. Looking at a couple crucial product categories is even more disconcerting. Consumer electronics (Best Buy's core business) was down 3%, while entertainment (this includes gaming, a historically strong holiday sector) was down 19.5%.
2. Rising rent
In retail, next to human capital, your most demanding fixed cost is real estate. Best Buy's rent expense for 2011 grew by 3% from $1.159 billion to $1.195 billion. Furthermore, projections for 2012 for rent increases of 2% and another 2% for 2013. These numbers may seem minimal, but the retail merchant's goal is to squeeze every nickel out of every square foot of rented space.
Rising rent and falling sales are enormous red flag. It also calls into question management's skill. Commercial real estate is still in the toilet. Landlords should be extremely flexible with retail tenants, especially an anchor tenant like Best Buy. Why is their rent rising in an environment where they should be stable at the very least if not more competitive?
3. Strong online sales
Wait... how is that a negative? Best Buy's online sales for December surged 26% year-over-year. There was also anecdotal evidence, per the financial media, of shoppers browsing Best Buy for items that they would eventually purchase online, thus earning the company the nickname "Amazon's Showroom" from the CNBC talking heads. You don't need an MBA to spot the trend: 20%-plus growth in one business line and negative growth in your core line. Who needs stores when you can go online?
In addition to the reasons discussed, there are other tell-tale signs of a stock in trouble. One of my favorites, although it's taken me the better part of a decade to spot it, is sell side analysts (research analysts from the big brokerage and banking firms) explaining away poor results when the company's underlying fundamentals are clearly deteriorating.
In a Credit Suisse Jan. 6 report, analysts surmised Best Buy's comps miss as follows: "In our view, BBY has a few arrows in its quiver that those facing the company head on seem to miss..." It's almost like an indulgent parent justifying a spoiled child's poor behavior.
Lastly, short interest in the stock has risen 22.7% in a month, from 30.14 million shares held short in November 2011 to 37.01 million as of Dec. 31, 2011. The stock has rallied a bit since the beginning of the trading year, however, Best Buy's shares are off more than 8% from a recent high of around $28. The stock price is currently lower than in September 2008 when Lehman Brothers failed and the financial crisis began. And although no one would consider our current economy a galloping powerhouse, things are noticeably better than they were back then, and best Buy just isn't cashing in on that.
Action to Take --> Is Best Buy headed to the retail bone yard this quarter? Probably not. But any sort of economic shock to the consumer can just about guarantee Best Buy a body blow that may send it reeling. The trend is not encouraging. It might be a good idea for investors to consider selling now before that happens.