Circuit City Sales Miss Big
"CC looks to be a case study of weak strategy meeting a tough business environment"
Circuit City is getting whacked today after announcing disappointing same store sales. Let's give their press-release the smell test and see what the miss may mean for Circuit City and retail Holiday sales in general
As is being widely reported, Circuit City (CC:NYSE) pre-released disappointing sales results for the quarter ending November 30th. As the sell-side takes their cue and unleashes the downgrade hounds on CC, with the stock already down greater than 10%, let's take a moment to run through the news release.
Our goals are two-fold: First to see what can be inferred about CC from the release (which, at 3-pages, represents all we will know until the December 17th earnings call). Is this another vapor retail turnaround skidding towards chapter 11 or a one-off miss making the "dip" in the stock worth chasing?
Our second, more important, objective is to pick through the details we've been given by CC and put them into the context of broader retail sales, particularly in consumer electronics. Is Circuit City a victim of a weak consumer, Best Buy (BBY) et al or some combination of both?
Let's go through the release and separate the factors CC cited for the miss into strategic whiffs (CC-specific mistakes) and red flags (trends that may be negative tells for other retailers) then put 'em together and see what we've learned.
The numerical details of aren't in dispute. CC posted -4.3% same store sales (SSS) vs. consensus estimates of a 2.1% gain. This gives us 640-odd basis points of missing to account for; from there it becomes a matter of interpretation.
CC opens the commentary with a classic management snow-job effort:
"Our sales performance did not meet our expectations (due)... first to our strategic decision to be less promotional than last year in music and movie software, coupled with a weaker new release schedule."
The problem with this explanation is that it intentionally mixes a stated strategic intent (100% under CC's control) with disappointing results that CC blames on something outside of their control (weaker new release schedule). CC (presumably) knew both the release schedule and their promotional plans when they created their sales targets.
Perhaps this is a subtle point but, as we'll see, it's a theme throughout the release and worth noting.
In terms of how much of CC's miss was due to weak entertainment sales, the company itself notes that the category was 13% of total sales in '04 vs. 14% in '03. The company offers that declines in this category accounted for 160 basis points of the sales miss. Thus they seem to have been planning higher sales despite less promotions and a weak line-up (simply bizarre).
CC attempts a similar psuedo-dodge on sales of satellite TV systems and wireless. They blame 120-basis points of their miss on digital video and 90-basis on wireless while simultaneously claiming that the shortfall in both cases were "principally driven by a business model change".
Between entertainment, digital TV and wireless Circuit City blames 370bps of their shortfall to plan on strategic decisions. It's a stance akin to pushing a broken car over a cliff then being "disappointed" when it won't start.
So far we haven't learned anything new that we can apply to other retailers. With the recent numbers from Echostar (DISH:NASD) and DirecTV (DTV:NYSE) it's clear that digital TV "weakness" is all about CC. As for entertainment, sales are weak (we've heard it from BBY as well) but not surprisingly so.
The most ominous signal from this release as it applies to consumer electronics in general is in video (TV's, DVD's etc) which accounts for 43% of CC sales.
The working assumption in consumer electronics is that the consumer rotating into hi-def televisions will be a boon for the industry. Higher ticket items, presumably higher margins and a bonanza of related accessories; this migration is seen as the land of milk and honey for CE retailers.
Seemingly in support of this idea, Circuit City saw triple-digit sales gains in displays, double-digit gains in LCD displays and digital imaging and single digit gains in digital televisions. "The rub", and it's a big one, is that double-digit decreases in tube televisions, DVD players and digital video service (which the company counts twice) offset those gains and led to total sales gains of 0 (zero).
This is simply remarkable given the hype in the space and the price points of hi-def displays. Between price declines at the high-end and consumer disinterest in the low end the result was that triple digit sales increases at the high-end weren't even enough to get total category sales up to flat.
Conclusions (NB: My opinions, not advice):
Circuit City remains an execution train-wreck. The company has inferior locations, a worse business model and, it would seem, lesser managers than their competition. They may not get picked completely clean by Wal-Mart (WMT) and Best Buy but they need some new ideas fast if they are going to survive.
I'm not interested in the stock of CC long or short. Decent balance sheet and buy-out risk remain the best parts of the long thesis and are good enough (particularly the latter) to keep me away from the short side; despite the facts of the first bullet point making the long side unappealing (again, only in my opinion).
Entertainment software (DVDs and video games) sales are generally soft. We've heard this from enough companies to assume it to be true (regardless of how "surprising" it may be).
It's still early in the Hi-Def migration but it's not unfolding as promisingly as it once seemed. While conceding upfront that CC is uniquely bad, their experience in video sales netting out to zero at this point in the Great TV Upgrade is concerning. If Hi-Def sets are going to sell simply as a function of price coming down even as that potential of lower prices all but eliminates sales at the low-end... well, that's a bit of a problem and not an idea built into the long-range thinking and planning for retailers.
If Wal-Mart's focus on electronics price cuts "hurts" BBY (and it does) it treats CC in a way that would make the Marquis de Sade blanch.
CC overpaid on the 4.5M shares they bought back at an average of $15.42 per share (and why on earth would they buy back shares with operations this bad?).
Put the December 17th earnings release and call on your radar. With sales results generally soft the last reed of retail hope is better margins. CC didn't guide eps lower. If the company managed to hit their number due to margins as opposed to s-t-r-e-t-c-hing the better operators in the space go unscathed by this and the Hi-Def margin promise is alive (if a little sickly).
The bottom line is that we can't make firm conclusions for other CE players off the CC guidance but we're getting some additional evidence that all is not particularly well in retail this season. While a firm conclusion is a nicer way to wrap a column, sharing the process and throwing it "out there" is more useful in regards to the real goal here which is getting ahead of the story in names before they warn.
I'm interested in what Minyan's are seeing in the stores and reports. Send your observations here and we'll see if we can't put together a decent thesis prior to the results being released!
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