NEW YORK (CNN/Money) -
No payments until January 2004! Zero-percent financing for the first 12 months!
Sounds like another ad for a Chevy or Ford truck, doesn't it? But guess what? Several retailers are following the lead of the auto giants this holiday season. And that might be bad news for their stocks.
Circuit City (CC: up $0.02 to $8.19, Research, Estimates), for example, is offering no-interest financing for 12 months on all TVs that cost more than $299. And at Best Buy (BBY: down $0.40 to $25.40, Research, Estimates), consumers using a Best Buy credit card don't have to pay interest on any purchase until January 2004. The consumer electronics chains are not alone, either. Sears is currently offering zero percent financing and no payments until July 2003 on its Kenmore brand of washers, dryers and refrigerators.
Since consumers still appear to be nervous about the economy, retailers are doing all they can to entice them to their stores. And that could wind up depressing retailers' bottom lines.
To that end, Circuit City and Best Buy are on tap to report earnings for their most recent quarter (which ended in November) on Tuesday morning. Analysts expect Circuit City to post a loss of 13 cents a share, compared to a 4 cent per share profit a year ago. Best Buy is expected to report earnings of 25 cents a share, flat with last year.
And the holidays aren't expected to help much. Both Best Buy and Circuit City are expected to report earnings declines for the current quarter (which ends in February).
"You always have to be concerned about promotions. Sales may materialize but profits may not," says Todd Kuhrt, a retail sector analyst with Midwest Research, a boutique firm that does not perform investment banking. No-interest financing and other sales incentives hurt profit margins, he notes.
Kuhrt says he has a "neutral" rating on Best Buy and Circuit City. In addition to being worried about the impact of zero-percent financing on profits, he says that the prices of consumer electronics goods in general are falling dramatically due to increased competition from discounters Wal-Mart (WMT: up $1.41 to $51.95, Research, Estimates) and Target (TGT: up $0.86 to $31.83, Research, Estimates). So even though the number of products sold might be higher this year than last, sales might be lower because of the price deflation, he says.
Another problem with these favorable financing deals is that consumers might not be as willing to spend on big-ticket items once the incentives are gone. This could hurt future sales. Ulysses Yannas, an analyst with Buckman, Buckman & Reid, a New York based brokerage firm that does not do investment banking, says that consumers are becoming increasingly savvy and are willing to hold out for deals.
Faced with that dilemma, retailers might have to extend the deals, which would continue to put pressure on profits. That's exactly what has happened with the big automakers.
The car companies first started offering zero-percent financing in the fall of 2001 following the Sept. 11 attacks. At the time, these programs were thought to be temporary. But General Motors, Ford and DaimlerChrysler are still aggressively promoting them. "People get used to the discounts," says Yannas.
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At first glance, though, it might appear that this is already priced into the stocks. Best Buy's stock is down nearly 50 percent year-to-date while Circuit City's is off 53 percent this year. Valuations appear reasonable as well, with Best Buy trading at 13.3 times earnings estimates for its next fiscal year (ending in February 2004) and Circuit City valued at 15.7 times fiscal 2004 earnings estimates.
Even Sears looks cheap, at just five times earnings estimates for next year. But the company already has problems in its credit card division. Due to mounting levels of uncollectible debts, Sears missed-third quarter earnings estimates by a whopping 28 percent. (And if Sears can't make money from high-interest-rate credit cards, you have to wonder how they'll fare with no-interest financing.) Shares of Sears (S: up $1.13 to $25.84, Research, Estimates) are down 47 percent this year.
So barring a major economic recovery, retailers like Best Buy, Circuit City and Sears will find themselves in a tough spot. End the zero-percent financing programs and sales might plummet. But if you keep them, already thin margins are probably going to get worse. Either way, it's tough to justify owning these stocks given these concerns.
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