UPDATE 3-Best Buy profit below view on expenses, shares off

(Adds analyst's quote, paragraph 3; valuations)

By Karen Jacobs

ATLANTA, Sept 16 (Reuters) - U.S. consumer electronics retailer Best Buy Co (BBY.N) posted a steeper-than-expected drop in quarterly profit as it spent more on store redesign and labor than anticipated, sending shares down 4 percent.

Best Buy has been spending to improve its stores and lay the groundwork for expansion, but some investors are concerned about the pace of investment as the U.S. economy weakens.

"Best Buy's error is being too aggressive, and we do expect the company to dial back expenses, but this lack of expense discipline/control is a periodic issue," Sanford Bernstein analyst Colin McGranahan said in a research note.

McGranahan rates Best Buy "market perform."

Net earnings fell 19 percent to $202 million, or 48 cents a diluted share, for the second quarter that ended Aug. 30, compared with $250 million, or 55 cents a share, a year earlier.

Analysts had expected 57 cents a share, according to Reuters Estimates.

Best Buy's selling, general and administrative expenses rose 17 percent in the quarter as it revamped its stores to add Best Buy Mobile shops. Musical instruments and Apple Inc (AAPL.O) computer departments have also been added to some stores.

The company also said it boosted labor hours in the quarter to help sales during the back-to-school shopping period. It said it would cut some overhead and travel expenses in the second half but would not scale back growth investments.

Chief Executive Brad Anderson acknowledged that the company has "some work to do in terms of managing our expenses amid a challenging macroeconomic environment."

IMPROVED REVENUE

Quarterly revenue rose 12 percent to $9.8 billion, better than the $9.67 billion analysts had expected.

Sales at U.S. stores open at least 14 months rose 5.3 percent, while total domestic sales rose 12 percent. The strongest-selling products included notebook computers, flat-panel televisions and cell phones.

International revenue rose 10 percent, but comparable-store sales declined 1 percent, hurt by weakness in China.

The Minneapolis chain, which trades at a price-earnings ratio of 13.83, faces a slowing spending environment as rising food costs and a U.S. housing slump pressure consumers. But it is faring better than rival Circuit City Stores Inc CC.N, which is expected to report a loss for its second quarter and is exploring strategic options.

Best Buy has stepped up its offerings in mainstay categories such as cell phones while moving into areas outside traditional consumer electronics. For example, on Monday, the retailer said it would buy digital music service Napster Inc NAPS.O for $121 million to reach new customers.

Earlier this year, the company paid about $2 billion to create a joint venture with Britain's Carphone Warehouse Group Plc (CPW.L) that will open Best Buy stores in Europe.

Investment income came to $9 million in the quarter, down from $22 million a year earlier.

Best Buy backed its previous full-year forecast calling for profit of $3.25 a share to $3.40 a share. Analysts have expected $3.29 a share, according to Reuters Estimates.

Best Buy shares closed on the New York York Stock Exchange down $1.24, or 2.8 percent, to $42.46, while Circuit City's shares rose 18 cents, or 11 percent, to $1.81. Best Buy shares have fallen 22 percent this year, while Circuit City is down 60 percent. (Editing by Gerald E. McCormick, Leslie Gevirtz)