In their Q2 earnings release, Best Buy signaled a significant expansion of their efforts in virtual reality products: “By holiday, we expect to be selling an expanded assortment of virtual reality products in the vast majority of our stores and more than 500 stores will be equipped with demo stations”. BBY’s CEO Hubert Joly practically gushed about VR as he described the advantages of a brick-and-mortar specialty electronics store like Best Buy in selling such a product. BBY currently sells the Oculus Rift with demonstrations, but only at selected outlets. It’s clear that BBY intends to broaden that approach substantially.
Joly is certainly right that VR as a product category is likely to be sold only after demonstrations. Any scan of product reviews on VR products will reveal both enthusiastic fans and some disappointed by artifacts and/or limitations on software. VR has also been plagued by reports of motion sickness among some users; thus it would make sense that before shelling out $600 for an Oculus Rift a consumer might want to try it out first. Thus Best Buy is in a unique position to push the VR market forward; by the time they have rolled these demos out to 500 stores, Best Buy will likely become by far the biggest demonstrator of VR technology in the US, if not the world.
Joly brought investors back to earth, though, with the next comment on VR: “I am not expecting a material financial impact this year given the timing of launches, inventory availability and the fact that we are early in the cycle”. What’s a “material financial impact” for Best Buy? One indicator can be found in their press release concerning domestic segment revenue: “we are reporting comparable sales growth of 0.8% versus guidance of approximately flat”. I found that statement a bit strange, because I would have considered 0.8% growth to be the same as approximately flat, but Best Buy reported that growth, so they considered it material.
Using Best Buy’s domestic segment revenue, the 0.8% represents $63 million in revenue, so if VR sales in the rest of the year will not be material, they should be less than $63 million. If we put an upper bound of $50 million for Best Buy VR sales, that would imply less than 100,000 units (likely much less) if all the revenue were Oculus Rift-type products at $600. This would compare with millions of TVs, PCs, tablets and phones during the same period.
So though VR is an exciting new product development, in the current generation the interest and purchase intent will be limited to true “early adopters”, and is still a long way from the mainstream market. BBY is undoubtedly trying to excite investors by tapping into VR hype, but they are responsible enough to be clear that in the current marketplace there’s more hype than actual purchasing.
Leaving aside the VR comment, Best Buy had an outstanding quarter, with revenues and EPS exceeding expectations. BBY seems to be executing well in a difficult environment; for more detailed analysis of Best Buy’s Q2 earnings report see my article “Best Buy Q2 – Swimming Strongly Upstream” in the Display Supply Chain Monitor, available at the store on the Display Supply Chain Consultants website.
By Ross Young
If you had invested $1000 in a basket of panel suppliers' stocks weighted by market cap on May 2nd, you would have made 12% or $118 by last Friday August 12th as shown in the figure below, an excellent return in just over 3 months. The 12% return was double the return of the S&P 500 (SPY) at 6% and 27% better than the emerging market index (EEM), which has also performed well over this time on rising oil prices, up 9%. However, if you would have focused just on Taiwan panel suppliers, you would have made an incredible 35%, 6X the S&P and 4X the emerging market index.
Display stocks have popped which can be attributed to:
Panel suppliers and research firms expect supply/demand to remain tight through 2017 which should result in improved margins and continued gains by the index. Who are the biggest winners so far? The stock price results by supplier since May 2nd are shown in the figure below. As indicated:
Note, DSCC’s new Panel Supplier Stock Index is updated and analyzed daily and sent to customers who upgrade to the daily option of The Display Supply Chain Monitor. The Panel Supplier Stock Index is based on each company’s stock price and # of outstanding shares with the market cap calculated and weighted for each company in $US and updated daily. Contact firstname.lastname@example.org for more information.
In my recent blog posts, I’ve given several signs that the TV market is pulling the LCD industry out of its slump (see “Can 4K Drive Replacement Cycle Growth in TV?” and comments in “Corning’s 2nd Quarter Earnings…”). Recently we’ve seen yet another strong sign: strong profits from the major TV brands.
With several LCD makers (LGD, AUO, Innolux) quarterly financial statements give a complete picture of the health of the LCD panel-making industry, because these companies are LCD “pure plays”. At the brand level, though, none of the leading global brands is reliant mainly on TV, but in each case the results of the TV business are reported in divisional results. Samsung reports sales and operating profit for Consumer Electronics, and reports sales only (not OP) for Visual Display, which is mainly TV and comprises ~60% of CE revenue. Similarly, LG reports sales and operating income of Home Entertainment, and Sony reports revenue and OI of Home Entertainment & Sound. The businesses including TV account for 21%, 30%, and 15% of the revenues of Samsung, LG, and Sony, respectively.
Because we don’t get full financial results for the TV business, it can be difficult to evaluate the health of the business. TV is a relatively low-margin business, as judged by return on sales, but it is also a low-asset business. A TV assembly factory requires an investment of the order of $100 million (for a vertically integrated player like Samsung; some TV makers like Sony outsource most of their TV production), compared to the $ billions required for the latest LCD fabs (with OLED even more expensive). Consequently, the biggest part of assets for the TV business is working capital, and asset turnover (sales / net assets) of 6x, 8x or even 10x is achievable. Thus a 5% operating margin represents 30% or higher return on assets, a very attractive return.
With the combination of healthy end-market demand and low panel prices, the three top brands achieved record-setting operating margins in Q2 2016. This chart shows the margins for these businesses since 2013:
Because of changes in division structure, longer-term comparisons are awkward: for example, prior to 2013 Sony included TV in a Consumer Products & Services division, which also included its substantial (at that time) PC business. However, the product division including TV at Sony last achieved margins like this in 2007, in the initial surge of LCD TV. For Samsung and LG, these operating margins are unprecedented in the flat-panel TV era.
So what are the implications of this strong profitability for the wider display industry? First, it eases the pressure on cost reduction and opens the door to panel price increases. When considering how much room panel prices can increase, consider that the Q2 profits of TV makers are based largely on Q1 panel prices, when the industry hit bottom. Although panel prices have increased 5-20% from their low points, they are still less than 1/3 the corresponding TV prices, so I think they’ve got room to increase further. Second, expect a spillover effect on IT panel prices, as panel makers shift capacity to TV. Third, expect an acceleration of expansion plans from the Chinese to take advantage of higher prices.
Finally, expect increasing competitive pressure in the TV space to push down TV prices, especially for sets with higher-end features. The TV business has historically been one with relatively low barriers to entry, and the global leaders will face competition from established Chinese brands like TCL, Hisense, Haier, and Skyworth. Further, we may see a new global player emerging with LeEco’s recent acquisition of Vizio. The combined entity has a strong position in the two largest and most competitive markets, and a track record in both companies of innovative business models and aggressive prices of high-featured TV sets.
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