Treasure Chest: Re-Rating For JB Hi-Fi

This story features JB HI-FI LIMITED. For more info SHARE ANALYSIS: JBH

-Guidance upgrade expected
-Capital management expected
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) is robust enough to stay on top of the Australian consumer electronics industry. That's what several brokers believe. Morgan Stanley thinks the consumer electronics and white goods retailer is the best in the class when it comes to performance and this is set to continue via earnings upgrades and capital management.

We'll next hear from the company when it delivers a trading update on May 9. At that point Morgan Stanley expects the company to raise guidance for FY14 profit to around $126-129m. Morgan Stanley's forecast sits at the high end of expectations, at $133m. Such an earnings upgrade would accelerate capital management expectations and the broker notes the company will also become debt free by FY16. Morgan Stanley believes this improved scenario emanates from several quarters. Furthermore, the valuation looks reasonable, not cheap, but providing an attractive entry point nonetheless. Hence, an Overweight rating and $24.00 target.

BA-Merrill Lynch recently upgraded the stock to Buy from Neutral, foreseeing double digit compound annual growth rates as achievable over the next three years. The broker thinks the company's earnings potential has been undervalued. The three growth avenues are new stores, further roll-out of the JB Home format and continued expansion of the commercial business. Even taking into account an expected decline in mature store earnings over the next three years, the broker thinks JB Hi-Fi can still grow earnings by over 30% by FY16. Merrills also believes a positive update on May 9 could drive a re-rating. The broker concedes that the consumer electronics industry remains highly competitive and elevated discounting may cause some near-term earnings pressure but, this aside, the stock appears undervalued when considering the organic growth potential. Merrills is encouraged by the JB Home roll-out and thinks another 50 stores by FY16 will drive meaningful sales growth.

For Morgan Stanley the underpinnings of growth are coming from a fragmenting of suppliers, new gaming consoles and the fact the company now has greater leverage to the housing recovery. Finally, the consumer electronics market is looking more consolidated and rational.

The broker wasn't always so constructive. There's been several issues plaguing the industry and keeping a lid on profits such as a shift to online software, flat panel deflation and the dominance of Apple. Now, the company's potential, that's yet to be universally acknowledged, is around capital management, increased margins via private label product and the white goods market. Morgan Stanley observes unprofitable competitors have now left. Harvey Norman, Retravision and Betta have all closed stores while department stores have reduced their consumer electronic footprints. Flat panel volume growth is now aligned with the replacement cycle rather than relying on increased penetration. Flat panels represent almost a third of the company's revenue and the market has been very weak over the past few years, as prices fell and the Australian dollar rose. Prices were then lowered to win market share.

Thee headwinds are now easing. Moreover, Apple, having represented 20% of the company's business in 2010, is losing market share in the smartphone and tablet market as manufacturers such as Samsung, LG, ZTE and HTC crank up their share. JB Hi-Fi tends to generate a higher margin from non-Apple suppliers. Morgan Stanley expects 2014 should produce healthy growth in the game category from pent-up demand. There were few games for the new generation consoles at the end of 2013 and this should be resolved this year. The broker thinks the new generation consoles could boost like-for-like sales growth by as much as 3% on an annual basis.

The company is also benefiting from a national store footprint and the diversification into markets that are more leveraged to the housing market. White goods products are typically purchased soon after a new home is acquired. JP Morgan has noted these improving trends too, becoming more confident that earnings margins are not set to decline further. This broker also retains an Overweight rating.

Where Morgan Stanley suspects JB Hi-Fi may be able to get one up on competitor Dick Smith ((DSH)) is by replicating the latter's success in private labels. Dick Smith, at present, generates higher gross margins than JB Hi-Fi and the broker suspects, given JB Hi-Fi's sales are three times those of Dick Smith, that this is largely down to private label products.

What about the capital management? The company pays out 60% of profit in dividends so has built a healthy franking credit balance over time. The company also has a history of returning capital and completed a buy-back in March 2011. JB Hi-Fi can purchase share at up to 14% discount to the prevailing market price and allow shareholders access to franking credits, so Morgan Stanley believes this would be the logical way to go. The ongoing accretion to earnings per share is key here, because it permanently reduces the shares on issue. The broker thinks an acquisition or special dividend is unlikely.

On the FNArena database the stock has five Buy ratings, two Hold and one Sell. The price targets range from $13.90 to $23.06 with a consensus of $20.20, suggesting 1.8% downside to the last share price. The dividend yield for FY14 and FY15 forecasts is 3.8% and 4.0% respectively.
 

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