Flat Panel Hype Takes Best Buy for a Roundtrip

By Dr. Duru written for One-Twenty

December 21, 2006

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Circuit City forced the hands of the remaining Best Buy optimists. On Tuesday evening, Circuit City produced an awful earnings report. Sort of like Best Buy amplified by three. It was the kind of ugly warning of margin pressure that I have been claiming has been in store for Best Buy. Circuit City got smashed for a 16% one-day loss, and the carnage amplified the damage already being done to Best Buy's stock after its own earnings misfire last week. Best Buy has now made the dreaded earnings roundtrip: the low of the day came at the same price Best Buy carried when it last reported earnings in September. At that time, the market first sold off the stock at what was definitely a disappointing report, but the unflappable optimism of this market rally encouraged folks to bid Best Buy up anyway in hopes of, yep, the saving graces of flat panel TVs. I did not understand it given the overtures WalMart was already making about going after prices in this area.

The Wall Street Journal quotes a research analyst who perfectly summarized the situation:

"Pali Research analyst Stacey Widlitz called Circuit City's gross margins 'a disaster' and said her Street-low estimate of 97 cents a share for the year will have to go even lower. 'We would not be buyers of the stock as we have hit the 20%+ household penetration level for new tech TVs,' she said. 'That is when discounters pile on and margins compress. We are not optimistic the TV cycle has legs from here out.'"

Too many folks, especially the retailers and the analysts, have been banking on flat panel TVs to deliver profit miracles. Even after WalMart promised to aggressively price these TVs, few thought it was a serious threat to the likes of Best Buy and Circuit City. It was the classic whistling past the graveyard scenario. Investors were encouraged to buy on any dip on this news. It turns out that things are even worse. Retailers have used these things to try to lure foot traffic into stores, but it has not worked as effectively as hoped. I was amazed this past weekend when I saw Home Depot, yes HOME DEPOT, selling flat panel TVs! Huh?!? I did not recognize the brands, but the prices looked pretty good from the cursory glance I gave the selection on display. Everywhere we look now, we see flat panel TVs for sale or being offered as tantalizing freebies to get us to do one thing or another. As analyst Widlitz declared, the high point for profits in this area have now passed by. The market has finally responded and taken back the premium (and confidence) it had placed on Best Buy to deliver on its promise to essentially make up the profits in volume.

So now the big sell-off I was thinking might be in store for Best Buy's next earnings report may already be underway. Too many analysts have already jumped ship from the story. Now it looks like there are no other hot gadgets (maybe gaming hardware?!) to save Best Buy from the much expected economic slowdown (sidebar - I remain befuddled at the logic of buying economically sensitive stocks in advance of an expected economic slowdown. But who am I to question the madness?). Another 10% drop and Best Buy will be back where it started the year. By the time the next earnings come, the sellers will be exhausted, not the buyers. Expectations will be reined in, the analysts sobered up, and the stock will have nowhere to go but up. It will be tough to make a call to buy before that earnings report though, no matter how bad things get in advance. This will be one to watch.

If you learn no other lesson from this mess, remember to be skeptical of the hype. Wall Street often operates on themes, regardless of whether there is a real, sustainable, underlying story. If the theme is catchy, simple, and seemingly intuitive, the faster folks can flock to buy it up. Thus, these themes go in and out of fashion. This flat panel theme was no different, albeit short-lived. As fast as a fad takes a stock to stardom is just as fast as the fashion police will throw all the revelers into the slammer at the end of the party.

Be careful out there!

DrDuru, 2006