Early holiday discounts hurt Best Buy's profit

(Reuters) - Best Buy Co's (BBY.N) quarterly profit missed Wall Street estimates as bigger discounts at the start of the key holiday selling season ate into profit at the world's largest electronics chain.

The news dragged Best Buy's stock down 15.5 percent and pressured the shares of smaller rivals RadioShack (RSH.N) and hhgregg (HGG.N) as investors worried that they also had to offer steep discounts to attract shoppers in the weak economy.

The results coincided with a report from the Commerce Department showing that U.S. retail sales rose less than expected in November, tempering some of the expectations of a strong holiday shopping season.

Unlike last year when Best Buy held the line on discounts and promoted only pricey items, this year it offered deep discounts on items including flat-screen TVs, promised to match any lower prices its brick-and-mortar rivals advertised during the season's peak, and even offered free shipping.

The strategic shift helped the industry bellwether report a 0.3 percent rise in sales at its stores open at least 14 months in the latest third quarter, reversing declines in the past five quarters, but hurt the company's profits.

"It is a very delicate balancing act. It is tough to get it right," said BB&T Capital Markets analyst Anthony Chukumba.

Total company gross profit dollars fell 2 percent during the quarter from the year-ago period.

"Increased promotions hurt gross margin, but we also believe the shift online with free shipping was a significant negative to the gross margin," analyst David Strasser at Janney Capital Markets said.

During the quarter that ended on the day after Black Friday, Best Buy's gross margin fell to 24.3 percent, while analysts such as KeyBanc Capital Markets' Bradley Thomas had an estimate of 25.2 percent.

Domestic gross margin also fell 130 basis points.

"The decline in domestic gross margins supports our view that the retailer will find it increasingly difficult to drive store traffic in a profitable manner over a longer horizon," Morningstar analyst R.J. Hottovy said.

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Graphic on Best Buy's third-quarter results: link.reuters.com/qur55s

Graphic on U.S. retail sales: link.reuters.com/fur55s

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In an interview, CEO Brian Dunn downplayed those concerns and said the company planned to stick with its strategy to offer compelling discounts to boost customer traffic, and then sell various high-margin services and accessories to them.

He also sees room to cut costs and thereby help profit.

"I am very confident about our ability to drive growth in both the topline and operating income dollars," Dunn told Reuters.

The key selling season that traditionally kicks off on Black Friday -- one of the biggest sales day of the year for retailers -- is closely watched by investors as consumer spending accounts for about 70 percent of the U.S. economy.

In its third holiday season after the bankruptcy of archrival Circuit City, Best Buy faces cutthroat competition from online retailer Amazon.com Inc (AMZN.O) and discounters such as Wal-Mart Stores Inc (WMT.N) and Target Corp (TGT.N).

"Retail has been very promotional and consumers have been very value-conscious," Dunn said on a conference call as he summed up the season so far.

Net earnings fell to $154 million, or 42 cents a share, in its third quarter that ended November 26, from $217 million or 54 cents a share a year earlier.

Excluding items, it earned 47 cents a share, missing the analysts' average estimate of 51 cents a share, according to Thomson Reuters I/B/E/S.

Total sales rose to about $12.10 billion, missing the analysts' average estimate of $12.14 billion.

Despite the lackluster quarterly report, the company backed its outlook for the financial year. It continues to see revenue of $51.0 billion to $52.5 billion, reflecting comparable store sales in the range of flat to a 3 percent decline.

Best Buy anticipates earnings per share of $3.35 to $3.65, including share repurchases, but excluding items.

Its shares ended down 15.5 percent at $23.73 on the New York Stock Exchange on Tuesday.

(Reporting by Dhanya Skariachan; Editing by Derek Caney, Maureen Bavdek and Matthew Lewis)