<FOOLISH WORKSHOP>

A Margins Best Buy

by Louis Corrigan (TMF Seymor)

Atlanta, GA. (Dec. 22, 1998) -- This week offers up a couple of model favs: Best Buy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %> and Quiksilver <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ZQK)") else Response.Write("(NYSE: ZQK)") end if %>.

First up is Best Buy, which delivered an awesome third quarter as all the stars aligned perfectly for this consumer electronics retailer. EPS soared 79% to $0.52 from $0.29 on an 18% jump in sales to $2.5 billion. Now that's rising margins! And EPS would have been three cents better without a debt prepayment during the quarter.

Comp store sales pumped up 12.2%, a compression from the 14.9% year-to-date number, but not too shabby. If Bloomberg is correct, the company apparently told analysts that comp sales for December are up 8% so far, way ahead of the 1% to 3% Best Buy has been predicting. Still, the company has begun to encounter tougher comps. For example, Q4 same-store sales last year rose 17%, a high hurdle to get over.

Gross margins edged up to 17.9% from 16% a year ago as new digital products like DVD flew off the shelves. The company's investment in inventory management is also paying off big time. Inventories were flat despite the sales increase and 28 new stores. Only sales, general & administrative expenses rose due to higher labor costs as the company paid employees bonuses for kicking butt.

Part of the margins story is that highly profitable service plans accounted for 3.8% of sales, versus 3.2% a year ago. After Best Buy tripped two years ago, management started pushing these service contracts with a force once seen only at Circuit City <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CC)") else Response.Write("(NYSE: CC)") end if %>. Sure, they're not a great deal for consumers, and you just want to slug the salesclerk when the spiel begins, but these contracts deliver fat profits.

Meanwhile, the balance sheet has made a big U-turn from a year ago. The company has cut long-term debt to $31.8 million from $211.6 million while $230 million in preferred stock has been converted to common stock. At the same time, Best Buy is now sitting on $409 million in cash versus just $122 million a year ago. The only item that isn't golden and isn't explained in the press release is the 41% jump in receivables to $278 million. Otherwise, Best Buy still looks great, even though the stock has paused for results to catch up with earlier gains. The margins theorem says keep holding if you own these shares.

Next up, cool surf clothes designer Quiksilver. Margins were down for the first half of the year but turned up in Q3 (EPS up 37%, sales up 34%). After those results came out in mid-September, the stock caught a wave from the mid-teens. It rose to $30 on Q4 results, which showed sales rising 57% and EPS surfing ahead 95%. The stock trades around fair value based on growth estimates, but some interesting initiatives are afoot. More on this in an upcoming Daily Double.

Finally, we'll take a quick look at Periphonics <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PERI)") else Response.Write("(Nasdaq: PERI)") end if %>, a company that makes automated interactive transaction processing systems that allow you to call up a company and get the info you want just by making voice or touch-tone requests. The company echoed a solid first quarter as Q2 sales grew 25% to a record $35.7 million and EPS increased 71% to $0.12. Higher margin revenue from system sales rose 27.1% to $27.7 million while maintenance revenues increased 17.3%. Still, gross margins rose during the period to a sprightly 47.8% from 47.2%.

A Daily Trouble 15 months back, Periphonics actually plunged 67% earlier this year into an early September low below $5. But the stock has now bounced back sharply to the current price of around $12 1/2. The Fool snapshot reveals a company with a solid balance sheet, including a little cash but a lousy return on equity of just 7.2%. Periphonics has clearly had some troubles, but analysts remain upbeat, with earnings estimates of $0.52 for the fiscal year ending in May 1999 (up from $0.33 in FY98) and $0.75 for FY 2000.

At least one director used the stock's dip this summer to buy heavily. The board also purchased 175,600 shares during Q2 at an average price of $7.24. With $21.3 million in cash left at the end of the quarter, the board perhaps should have been more aggressive in buying back shares (a repurchase of up to 800,000 more had been authorized). But I don't know what Periphonics may need the cash for, so that's just a stray observation. This could be worth a closer look, but the stock has been volatile and appears to discount at least near-term growth.

That's all we have space for, but National Data <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NDC)") else Response.Write("(NYSE: NDC)") end if %> and Paychex <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PAYX)") else Response.Write("(Nasdaq: PAYX)") end if %> also deserve a look.

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database