JB Hi-Fi Praying For A Good Christmas

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

By Greg Peel

The logic is straightforward – Australia's second quarter GDP growth was about 50% greater than expected and unemployment is well on its way back down to pre-GFC levels. The discretionary Australian spender, who went missing after the Pennies from Kevin had gone, should be shooing the moths out of the wallet well and truly by now. We should be looking forward to a very Merry Christmas in retail land.

Well it would want to be, if you're a retailer.

FNArena has recently been undertaking an extensive examination of the FY11 prospects for the Australian consumer discretionary sector (There Are Other Stores Like David Jones; Retail's Downward Paradigm Shift; Deflation Ahead For Electronics Retailers?; Consumer Spending Not As Weak As Some Suggest; among others). The general findings flowing from the examination may be summarised as follows:

Consumer spending is on the improve in Australia but not making its way into typical discretionary retail items;
Earnings growth amongst retailers is more about cost cutting and less about revenue growth;
The Australian consumer has been frightened by the GFC and assumptions of a return to the pre-GFC spending frenzy are misguided;
The benefits of a stronger Aussie are lost given lower prices are not translating into stronger volumes;
Pending RBA interest rate rises (and/or independent bank rises) provide significant downside risk to sales;
Discounting continues, and electronic goods in particular are facing price deflation from oversupply.

One might suggest that all the above points were borne out, one way or another, in management comments at yesterday's JB Hi-Fi annual general meeting.

While Harvey Norman ((HVN)) may be the most recognisable of Australia's electronics retailers, the real stock market darling of recent years has been JB Hi-Fi ((JBH)), a company slightly more skewed towards the Gen X/Y spender. While Harvey Norman's franchise model has its benefits, JBH's business strategy has long been praised by stock analysts and its constant store roll-outs enough to leave some shaking their heads in admiring disbelief. In short, JBH has rocketed out of the GFC depths to be about 30% up in share price from the pre-GFC peak.

While Australian electronics retailers have an advantage in that Aussies are pretty keen to buy the newest toys, and JBH an advantage in being a go-to place for the young to buy music machine and smart phone paraphernalia, all retailers have had their sales and earnings numbers distorted over the period from firstly the government's fiscal stimulus hand-outs and then the dark days following the end of the spending honeymoon.

One phenomena resulting is that twelve months down the track, retailers were initially hard pressed to match stimulated sales growth numbers (and indeed fell short) but now are looking forward to making growth comparisons to the post-stimulus vacuum. It shouldn't matter to the sensible investor, but it does seem to matter to the market. When JBH reported its FY10 result in July, commentary centred around the impact of having to “cycle” previously “stimulated” numbers. But subsequent months have now taken us to twelve months out from the vacuum, so numbers up to Christmas should be easy to beat impressively. That is, if Christmas sales prove as strong as retailers, and most analysts, are assuming.

We're only one quarter into FY11, but already JBH has been forced to make a profit guidance downgrade. It was a bit of a backdoor downgrade so you had to be paying attention. Management noted that like-for-like sales growth of 12.2% in FY11 to date was running about 5% behind budget. But it “expects to make up part of this shortfall in the second half”. “Part of the shortfall?” queries RBS Australia. Management left its full-year sales growth guidance intact at 17.7% so either something else has to give or this was actually a downgrade.

The reasons for the behind-budget sales performance are straightforward. Prices for electronic goods are falling sharply (the price deflation noted above) but this is not attracting a commensurate lift in sales volumes. New iThings are seeing decent sales but flat-screen TVs are gathering dust. It had to happen eventually – everybody who wanted a flat-screen TV to replace the old box now has one, and some are on to number two or three to catch up to digital and hi-def technology. The revolution's over.

The next step should be 3DTVs but so far the punters are wary. Even with discounting and a strong Aussie the teles are expensive, and if you really enjoy sitting around in sunglasses feeling nauseous it would be cheaper to go deep sea fishing. Could 3D prove one technological step too far? (As a teenager of the seventies, I am reminded of 8-track cassettes and quadraphonic sound systems.)

Despite the 5% shortfall the sales trend is still to the upside nevertheless, and we're now approaching Christmas. JBH is expecting to see iPads fly out the door. (Just don't tell them Americans are seeing iPad sales cannibalise notebook sales). This brighter Christmas, driven by a strong economy, strong employment and steady house prices, should lead into a bright second half of FY11, so JBH suggests.

And there's always the relentless roll-out of new stores. JBH expects 12 new stores before Christmas and 18 in FY11. But Citi calculates new stores to add 12% in sales growth, and sales growth year-to-date has only been 12%. That implies flat same-store sales on a net basis. Citi nevertheless expects sales margins are remaining relatively firm.

Credit Suisse nevertheless does not think JBH will make its like-for-like sales growth targets.

In general, analysts are prepared to take management on its word. The only change to previous ratings in the FNArena database was an upgrade to Hold from Sell from RBS but that was a reflection of a weaker share price. The Buy/Hold/Sell ratio sits at 3/4/1 (Credit Suisse is the non-believer) with a consensus target of $22.12, down from $22.21 pre-AGM.

But all analysts warn that earnings risk is to the downside. Realistically, JBH and fellow retailers need a good Christmas to jolt spenders back to a more “normal” 2011. Gerry Harvey, in the meantime, has labelled current business conditions “worse than the GFC”. Analysts will be stalking the stores in the next couple of months, looking for signs of a Christmas rush.

But just don't mention those two interest rate rises we could well be hit with in both November and December, and the extra basis points the banks will add to their mortgage rates.

Merry Christmas.

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