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hhgregg Remains Neutral

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We are maintaining our Neutral recommendation on hhgregg, Inc. , a specialty retailer of premium video products, following an appraisal of its second quarter fiscal 2013 results.

hhgregg’s second quarter earnings of 11 cents per share exceeded the Zacks Consensus Estimate by 22%. However, the quarter’s earnings lagged the prior-year quarter earnings by 31%. Lower revenues and higher selling, general and administrative expense ratio led to the earnings decline.

hhgregg’s net sales dropped 5% year over year to $587.6 million in the reported quarter due to 8.8% decline in comparable store sales. Sales also fell shy of the Zacks Consensus Estimate of $640 million. The poor performance of video and other categories resulted in the comparable sales decline. However, improved margin rates in the video category drove gross margins higher by 107 basis points to 29.6% in the quarter.

Overall, we are encouraged by the company’s initiatives to drive additional traffic and increase sales. Strategic initiatives like restructuring of in-store management team and introduction of new categories have grown its appliance market share.

The company has expanded its computing and mobile phones category by introducing notebooks and desktops along with Verizon smartphones, which previously only included computers and tablets. Management has plans to fully roll out furniture and exercise equipment at all its stores in fiscal third quarter 2013. Management claims that these new categories will cover less store space and will not affect existing products and yet boost sales.

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 new stores in fiscal 2013, predominately in St. Louis, Missouri and Milwaukee, Wisconsin.

It also redesigned its website during the second quarter of fiscal 2013, which offers options to buy products online and ship them directly to consumers. The new website thus provides an enhanced purchase experience and boosts the company’s multi-channel retail strategy.

However, the company has been experiencing disappointing results in the video category due to lower-than-expected margins across all screen sizes. In addition, promotional activity within the video category has resulted in a reduction in the gross profit margin rate for the category.

Though management’s decision to focus more on the large screen video category improved the gross margin rate, the loss of overall market share of televisions resulted in poor performance of the video category in the second quarter of fiscal 2013. We do not expect the company to find the right mix of gross margin rate and market share in the next few quarters and thus remain on the sidelines.

hhgregg currently has a Zacks #3 Rank (short-term Hold rating), in sharp contrast to its peer Best Buy Co. Inc. (BBY - Free Report) , which holds a Zacks #5 Rank (short-term Strong Sell rating).

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