BBY with an inline Q with comps down 10%, margins in-line with gross margin slightly ahead. Gross margin improved year over year domestically up 70bps with several factors combining for the lift, which were service mix, lower costs in service operations, product margin improvement (even with elevated promotions), and help from credit. All of those make sense to us except the last, but BBY gave important color on the call around credit revenue (props to management to actually providing this critical detail, few companies are). The CFO noted “additional context on the profit sharing revenue from our credit card arrangement, which we have now called out as a benefit to our gross profit rate for the last 8 quarters. In fiscal '23, the profit share was approximately 1.4% of domestic revenue, an increase of 50 basis points compared to fiscal '20. The growth was driven by the increased usage of our card both at and outside of Best Buy and a favorable credit environment. Our outlook for fiscal '24 assumes that profit share will have a slightly negative year-over-year impact on our gross profit rate for the remainder of the year.” As we understand the credit partnership here, profit share has roughly a 100% margin flow through. So you have arguably ~1/3 of EBIT coming from credit (1.4% of sales with ~4.4% margins last year). As balances went up and credit quality went to peak credit ADDED 50bps of margin. But now credit is going from tailwind to headwind, meaning there is arguably at least 50bps of incremental margin risk from credit alone, and the potential for much more if we see a truly weak consumer credit environment with recessionary levels of delinquencies and bad debt expense. As for the trend in the retail business, comps are still ugly, though perhaps going to get a little less bad with BBY guiding to down 6% to down 8% after a down 10% this Q. Still we think the full year guide and implied hockey stick in business trends is far too bullish on the rate of improvement in consumer discretionary spending. So the TREND setup is comp pressure relative to street expectations, SG&A deleverage risk, and an incremental credit headwind. Longer-term we think BBY margins are structurally lower due to the online penetration trends and the impact of lower attachment of warranties and credit on ecom transactions as opposed to ones done in store plus permanently higher non supervisor hourly wages in the store. We think you have earnings downside to $5 to $5.50 and stock downside to the mid to high 50s vs current $71. This is a Best Idea Short that we don’t think is done.
Takeaway: Comps bad, perhaps to get less bad. Management gave important credit color, but it’s a bearish credit inflection point.
