Australia | May 06 2013
-Sales upgrade buoys market
-Brokers question the resilience
-What will replace software as a category?
-Apple, key product and key challenge?
By Eva Brocklehurst
JB Hi-Fi ((JBH)), the appliance and consumer electronics retailer, may have buoyed the market with its upgrade to sales figures for the four months to April but most brokers need more convincing that better times are here to stay.
Deutsche Bank observes that consumer electronics is highly dependent on the product cycle and typically suffers from deflation and device consolidation. The broker's main concern is that 24% of the company's sales are derived from software, a category which is in structural decline. One of the reasons JB Hi-Fi has remained so relevant has been the fact that it offers a broad product catalogue. Reducing floor space in this category could undermine the value proposition, such that floor space will become less productive over time. Although the broker commends the agility of management, citing the move to IT from car audio, there's no evidence there is a new category to replace software. Digital sales may help but, because that area is very competitive, the benefit for JB Hi-Fi will likely be modest. The new commercial category will only help a bit.
CIMB has come out in favour of the stock, suggesting sales growth is a good sign, particularly in the appliance category. The broker highlights comments from management that electrical items within the concept stores have not been affected by the addition of whitegoods to the range, a positive sign for expanding the format. Moreover, Australia is not experiencing the level of discounting seen in the prior comparative period, although the New Zealand business is considered patchy. CIMB upgraded the rating to Buy from Hold.
Most earnings estimates were upgraded following the trading update, which confirmed that sales in the four months to April grew 3%. Macquarie notes this sales performance occurred despite March and April cycling the launch of the new Apple iPad in the prior comparative period, which may have affected sales in those months by up to 5%. JB Hi-Fi indicated the new commercial division has a sales potential of around $500 million. Macquarie finds there's no timeline for this but notes the recently acquired 51% stake in Network Neighbourhood provides an entry opportunity to the Victorian education market. As yet, the broker ascribes no earnings or value to the commercial division.
Another area of potential is video streaming. JB Hi-Fi has partnered with Ultra Violet to provide digital access to movies purchased to stream on any device via its NOW Video application. Macquarie sees an advantage from this in building customer digital libraries with JB Hi-Fi.
Citi, on the other hand, decided to plumb for a Sell rating as did Credit Suisse. The reason? They're just not convinced there is enough to drive continued improvement. Australian comparable stores sales were up 3.3% in the second half compared with being down 3.4% in the first half. Citi observes the major positives have been tablet sales, better computer game sales and software market share gains. The key here is "have been". These numbers will be difficult to improve on in 2014. Particularly, Citi notes, as the tablet category is susceptible to a hangover, with price deflation likely to overtake volume growth next year. The broker highlights the fact that JB Hi-Fi has less operating leverage than most retailers, given a low gross margin of 22%. The fact that better sales only contributed natural leverage suggests theres no incremental upside in gross margins, and the IT category is just so competitive.
BA-Merrill Lynch believes the stock is too expensive. This broker finds, to justify the current share price, earnings forecasts would need to be upgraded by a further 10% at least in FY14 and this is just too optimistic. Especially, as there is risk around the softening macro environment and continuing strength in the Australian dollar. As well, there is the lack of significant new products in the pipeline. BA-Merrill Lynch also thinks that deteriorating industry trends and willingness of competitors to operate off lower margins could see JB Hi-Fi's margins coming under pressure. This will be exacerbated by the limited ability to reduce costs and the fact that the new store roll-out is nearing the end.
A challenge for JB Hi-Fi is that there has been a significant change in the market structure of consumer electronics retailing since last year, according to JP Morgan. There could be more to come. Any further consolidation could be driven by the challenging environment for discretionary retailers and the lack of compelling new product development to drive purchases. A reduction in the risk appetite of credit insurers could also act as a catalyst. JP Morgan also notes the increase in Apple stores in Australia could present challenges. The broker emphasises that JB Hi-Fi is not expected to lose its re-seller status with Apple but does suggest the competitive threat is increasing. JB Hi-Fi has built a reputation for selling Apple product and this distinguishes it from peers such as Harvey Norman ((HVN)), David Jones ((DJS)) and Myer ((MYR)).
For JP Morgan, the price/earnings multiple has increased for the stock but it isn't onerous and not unreasonable, given the FY13 earnings growth and lack of weather risk for the retailers. The dividend yield, while lower because of the recent share price performance, provides a reasonable return in a market focused on yield, in the broker's opinion. On consensus estimates for FY13 and FY14 on the FNArena database the dividend yield is 4.1% and 4.2% respectively. The consensus target price is $14.77, signalling 13.8% downside to the last share price.
There are mixed ratings on the FNArena database. The three Sell ratings are held by BA-Merrill Lynch, Citi and Credit Suisse. There are three Hold ratings, and two Buy – Macquarie and CIMB.
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