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Following the first quarter 2012 earnings, we are downgrading our recommendation on Hhgregg, Inc. (HGG - Analyst Report) to Underperform from Neutral.

Hhgregg posted first-quarter 2012 net loss of 2 cents per share, which was below the Zacks Consensus Estimate of a break-even as well as the year-ago quarter earnings of 7 cents. The loss reflected a 13.2% drop in comparable store sales with an increase in SG&A expenses.

Moreover, Hhgregg’s top line inched down 1.0% to $431.5 million during the quarter. Gross margin, based on net sales went down 16 basis points to 30.2% in the quarter, resulting from the shift within the net sales mix of the company’s product categories.

Net sales mix has continued to shift from ‘video’ category to ‘appliance’ and ‘home office’ categories due to continued industry weakness. The decline in video category’s sales was attributable to double-digit decline in average selling prices as well as a slight decrease in unit demand. The improvement in comparable store sales for the home office category was due to an increased offering of computers and tablets along with associated peripherals.

Going forward, we also expect net sales and operating margin to remain muted owing to the seasonal shopping patterns, rising costs and competitive pressures.

Although Hhgregg has taken many strategic initiatives to boost its performance, including the expansion of its better performing home office category, mix shift toward high margin appliances category and launch of its redesigned e-commerce site, we believe that the consumer electronics and appliance industry exhibits high competition and is concentrated among a group of major retailers.

Hhgregg stores compete with consumer electronics retailers, specialty home office retailers, mass merchants, home improvement superstores and a number of direct-to-customer alternatives. The aggressive competition may weigh upon the sales and margins of the company. Hhgregg further faces stiff competition from Wal-Mart Stores, Inc (WMT - Analyst Report) and Best Buy Co. Inc. (BBY) and it currently holds a Zacks #5 Rank, which implies a short-term Strong Sell rating.

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