Is the Best Buy crash an overreaction to the retail ‘crime wave’?

Electronics retailer Best buy (NYSE: BBY) was slammed into the stock market after the release of its third quarter earnings report on November 23 which revealed potentially alarming trends. So far, the company had enjoyed a strong bull run with its stock up some 40% for the year. However, with organized crime actually big enough to squeeze margins and the company leaving its forecast largely unchanged, the headline plunged in response.

Here is why the market can overreact, but also why caution is probably in order.

A wave of retail theft continues

In the first half of September, chain of grocery stores and pharmacies Kroger (NYSE: KR) revealed that a considerable amount of goods was exiting the gate from many places without first visiting the checkout. The theft (called “shrinking”) reduced Kroger’s margin, according to CEO Rodney McMullen, accounting for 15 of a 60 basis point drop in gross margin. During Kroger’s second quarter earnings call, McMullen remarked on how the contraction was “heavily driven by organized crime or at least appears to be.”

Image source: Best Buy.

“Organized crime” in this case refers to loosely associated groups or “flash mobs” of thieves. Kroger’s geographic spread could increase the theft rate, with California accounting for nearly 10% of its stores. This state’s new policy, reducing thefts under $ 950 to a misdemeanor, means police often don’t bother to investigate. For example, the Golden State now has two of the top five US cities for retail theft.

Today, the same trend is eating away at Best Buy’s margins. In an interview with CNBC, CEO Corie Barry said groups of thieves “target stores, enter and collect large quantities of goods and run away.” In addition to squeezing margins, Barry stressed that “for our employees these are traumatic experiences, and they are happening more and more.”

Calling the rise of surface theft a “horrific change in the trajectory of the business,” she said the wave of crime was affecting worker retention, possibly causing frightened employees to leave while there already had a labor shortage.

Barry also identified California as an epicenter of theft, but said major cities elsewhere were seeing the same trend as well. The third quarter earnings report itself shows a 60 basis point drop in total margin year over year, from 24% to 23.4%, as a result. Promotions and other factors also contributed to the crisis.

Less than remarkable gains year over year

Best Buy’s third quarter saw its key financial metrics improve from last year’s results, but narrowly. Revenue grew a meager 0.48% year-over-year, while comparable national sales, or comps, grew only 2%. Earnings per share (EPS) grew only 1%. The company’s annual forecast increased only slightly, while several metrics remained stable compared to previous forecasts.

However, zooming out a two-year comparison reveals a more optimistic growth path. Third-quarter revenue of $ 11.9 billion jumped more than 22% from two years ago, while adjusted EPS rose 84% to $ 2.08. Without a doubt, last year’s results were skewed by COVID-19. Just as some businesses saw their sales slump due to the lockdowns, Best Buy clearly won as people stayed home and bought additional electronics to support their work and play. But in the longer term, Best Buy still seems to be performing robustly.

Has the market overreacted to the Best Buy report?

Best Buy’s stock price plunged nearly 16% on the day it released its third quarter results, although it rebounded to a 12% loss at the close of trading. The negativity persisted into the next day, raising questions as to whether Wall Street is right in its pessimism or whether investor sentiment is overreacting to the results.

Neither Best Buy’s slightly weak performance nor its shoplifting issue seems sufficient on its own to explain such a sharp drop. What seems likely is that the two factors combined surprised investors in a sell off, which then fed on itself. The theft, while it may continue or even increase in the face of an ineffective government response, has so far only lowered margins by a few basis points.

Sales are showing reasonable growth and profits have increased significantly over the past two years. At this point, Best Buy still looks like decent, but not exceptional, positive retail inventory that might be worth considering.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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