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hhgregg Upgraded to Neutral

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We recently upgraded our recommendation from Underperform to Neutral on hhgregg, Inc. , a specialty retailer of premium video products. Fourth quarter 2012 earnings of 39 cents per share, exceeded the Zacks Consensus Estimate by $0.02 per share. Sales also climbed 21% in the quarter due to the addition of 35 new stores.

Our 2013 estimates have gone up from $1.20 to $1.21 per share with our revenue estimate increasing from $2,764 million to $2,765 million. We are encouraged by the launch of a new mobile department to drive sales. Hhgregg is also witnessing an improvement in customer traffic.

hhgregg has been expanding its stores into new markets for the last few years. The company has opened or acquired stores in 14 new metropolitan markets in the past five years, most recently in the Chicago, Illinois and Miami, Florida markets. Hhgregg further plans to open 20 to 22 new stores in fiscal 2013, predominately in St. Louis, Missouri and Milwaukee, Wisconsin.

hhgregg has implemented several initiatives in fiscal 2012 to drive additional traffic and increase sales like restructuring of in-store management team and introducing new categories to grow its appliance market share as well as develop its computing and mobile phones category, which previously only included computers and tablets.

It also redesigned its website during the second quarter of fiscal 2012, which offers options to buy products online and ship products bought online directly to consumers. The new website design thus provides an enhanced purchase experience and enhances the company’s multi-channel retail strategy.

However, the company has been experiencing disappointing results in the video category, driven by lower than expected margins owing to the promotional activities across all screen sizes. hhgregg’s gross margin, as a percentage of net sales, sunk 91 basis points to 30.5% in the fourth quarter, caused by changes in product mix due to higher sales of computing and mobile phones which carry lower margins.

In addition, promotional activity within the video category has resulted in a reduction in the gross profit margin rate for the category. Management also expects the scenario to remain the same in fiscal 2103, when gross margin is expected to remain under pressure.

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