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Extra3/30/2009 12:01 AM ET

How the flat-screen TV saved Best Buy

After alarming investors with a dire outlook on consumer spending, the retailer discovered that there are some products shoppers simply must have.

By BusinessWeek

While consumers may be cutting their discretionary spending, not all gadgets are discretionary -- and for many households, the essentials includes flat-screen TVs and laptop computers.

That's one lesson from Best Buy's (BBY, news, msgs) earnings report for the three months through February, which beat Wall Street's expectations and pushed the electronics retail chain's stock up 12%.

Analysts said the fiscal fourth-quarter results at the world's largest consumer electronics retailer offer hope that consumers are beginning to spend again.

Many shoppers slashed all but necessary purchases last fall as they watched job losses mount and the stock market tumble. The paring back extended through a dismal holiday sales season and helped drive Best Buy competitors Circuit City and Tweeter out of business.

Best Buy had alarmed investors last November with a dire report on consumer cutbacks. Inventories were scaled back in anticipation of the slowdown. But that move cost the Richfield, Minn., company in February, when some stores ran out of items that shoppers wanted.

"It's challenging to accurately gauge the level of demand, which has resulted in inventory gaps that have limited our ability to fully meet customer demand," President and Chief Operating Officer Brian Dunn said in the company's earnings release. Dunn is slated to become chief executive in June.

Analysts say the retailer's fourth-quarter earnings and its improved forecast for the rest of 2009 suggest that demand for electronics -- albeit diminished -- remains steady.

"You're basically looking at an industry that's about 20% smaller than it was a year ago in terms of sales," says Michael McNamara, the vice president of research and analysis at MasterCard Advisors SpendingPulse, which tracks retail spending. "One theory is that (shoppers have) made the discretionary cuts, and now we're in a more stable environment."

The retailer reported strong gains in notebook computers and flat-screen TVs in the recent quarter. That reflects a growing number of consumers who consider such goods closer to necessities than luxuries, says David Schick, retail analyst at Stifel Nicolaus. "There is some reassessment of what is discretionary and what is not," Schick says.

Stephen Baker, the vice president for industry analysis at retail analyst NPD Group, agreed that Best Buy's sales figures show how closely consumers hold their gadgets these days. "If your car died, you have to get a new car. If you're having a problem with your computer, you need to get another computer," he says.

Not all types of devices saw gains at Best Buy. Sales of personal electronics, such as MP3 players, digital cameras and GPS devices, fell by double digits.

Flat-panel TVs and computers are "family" items that households may value more as they cut back on other entertainment expenses, such as dining out.

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"If you're not going out so much, it brings the outside world into the house," Baker says. The market for flat-panel TVs is only about 50% penetrated, he added, and because prices have dropped significantly in recent years, many consumers are ready to make the purchase.

Low oil prices may have also helped the electronics sector and other retailers. Cheaper gas compared with a year ago amounts to a "huge windfall" for consumers that may have helped free up cash and fuel spending on electronics and other discretionary purchases, says Joseph Carson, director of global economic research at Alliance Bernstein.

Carson says that overall consumer spending, excluding autos, may pick up despite the hit that households have taken from plummeting personal wealth. Outside of the richest consumers, "decisions to spend are less tied to net worth. They're tied more to income, jobs and price changes," he says, so such factors as lower gas prices may outweigh unease about their portfolios.

Carson also said Best Buy's results reflect modest consumer spending increases across the board in January and February when autos are excluded -- gains he says are encouraging because they started even before stimulus-related tax cuts began to appear in paychecks.

"You've seen recovery in some segments of demand," he says. While it's too soon to call a recovery in spending, Carson says the gains, when bolstered by the stimulus, could mean consumers are ready to open their wallets again.

This article was reported by John Tozzi for BusinessWeek.

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