Downgrades Follow Harvey Norman Sales Result

This story features HARVEY NORMAN HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: HVN

By Chris Shaw

First quarter sales from retailer Harvey Norman ((HVN)) have disappointed the market, with comparables sales growth for the period rising by better than 4.0% but like-for-like sales growth of just 2.1% being well below expectations. UBS, for one, had been expecting a 4.5% like-for-like increase.

[Comparable sales or “comps” measure a change in sales figures across one year for the same quarter, irrespective of any changes made in the meantime such as acquisitions, store expansions etc. Like-for-like sales adjusts for the latter to provide a more realistically comparative measure.]

Increases were recorded in furniture and bedding sales but these were not enough to offset weaker IT sales, though Deutsche Bank saw little in the numbers to be of immediate concern as it takes the view IT sales were distorted by sales being brought forward to benefit from tax rebates and stimulus payments or were being delayed as buyers wait for the release of Windows 7.

As well the broker suggests the historical correlation between comparable sales and earnings margins is reasonably low, so it saw no reason to change its earnings forecasts as a result of the sales figures. UBS disagrees and has trimmed its earnings numbers as a result of the sales announcement, though the reductions to its estimates are small as the broker points out furniture and bedding sales are typically higher margin.

In earnings per share (EPS) terms, UBS has lowered its numbers by 2.1% this year and by 1.9% in FY11 to 25c and 30c respectively, while Deutsche Bank is forecasting 28c and 31c and RBS Australia is at 26.5c and 29c, which reflects cuts of around 3% and 6% respectively to its numbers.

In contrast JP Morgan actually lifted its earnings estimates post the sales result, with its FY10 numbers increased by 1.5% and its FY11 forecasts by 1.2%. In EPS terms the broker expects 26.3c and 29.5c. Consensus EPS forecasts according to the FNArena database are 26.2c for FY10 and 30.6c for FY11.

Post the result the stock has received some downgrades in rating, largely on valuation grounds as the shares have rallied by around 20% since August. Deutsche Bank has moved to a Hold rating from Buy previously as the shares closed last week above the broker’s price target on the stock of $4.30. In its view, in relative terms there is now better value to be found in JB Hi-Fi ((JBH)), so the broker is recommending a switch in exposure.

UBS also downgraded to Neutral from Buy previously as in its view there is little chance of outperformance in the stock in coming months. The the company is now “cycling” tougher comparable sales results given this time last year stimulus payments were pushing up the level of consumer spending.

The broker’s forecasts imply an earnings multiple on the stock of around 17.6 times at present, which it points out is a premium to the market of around 18% and one that is tough to justify given the outlook of both tougher comparable numbers in coming months and pressure being placed on margins and volumes from the company’s continued struggles in growing returns in its operations in both Ireland and New Zealand.

RBA Australia has similarly downgraded to a Hold recommendation as it, too, sees no obvious catalyst for the share price in coming months, which suggests the stock will range trade for a while. JP Morgan is more confident though and retains its Overweight rating, suggesting concerns over the company’s margin outlook are misplaced, especially with respect to its franchising operations.

The broker also takes the view the improved outlook for the Australian consumer is positive for group sales going forward, as interest rate increases are already being priced in and the rate of increase in unemployment remains benign. As well, the broker doesn’t see upcoming comparative sales figures as terribly demanding, especially as it sees computer sales being a positive for the group in the second quarter.

But Macquarie takes the opposite view, seeing reasons to be concerned about the format of the group’s stores given growing signs of difference between the shopping habits of those buying IT and audio visual equipment and the habits of those purchasing whitegoods, furniture and bedding.

In the broker’s view the current store format is more suited to the latter category, but the trend for the former is towards positions with heavier foot traffic and more convenient locations. This confusing brand position is proving unable to stop the slowing in sales growth and margin compression being experienced, so the broker sees little scope for the stock to outperform.

Macquarie’s Underperform rating is matched by Credit Suisse, while the FNArena database overall shows one Buy rating, six Holds and two Sells. The average price target on the stock is $4.32, up from $4.19, thanks largely to Citi lifting its target to $4.55 from $4.00 previously. This reflects the broker’s view the state of the Australian economy should support housing related products, which makes the stock reasonable value relative to peers.

Shares in Harvey Norman were weak on Friday post the release of the sales result and today this trend has continued with the stock down 3c at $4.41 as at 1.30pm. Over the past year the shares have traded in a range of $1.805 to $4.85.

Click to view our Glossary of Financial Terms