Dick Smith May Raise Competitor Hackles

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

-Pricing to remain aggressive
-Is discount to peers justified?
-Confidence key to re-rating
 

By Eva Brocklehurst

Dick Smith Holdings ((DSH)) has signalled its innovative approach will give competitors a run for their money. The company improved on prospectus forecasts in FY14 and brokers lauded a good performance in the midst of a downturn in the retail environment.

Credit Suisse observes the FY14 improvement was largely a function of price investment and promotions. FY15 has started strongly, with like-for-like sales up 1.8% over the first seven weeks, but the broker suspects some of this growth has come at the expense of gross margins, and will continue to do so. The broker has revised up expectations for FY15 earnings, marginally. The company appears to be gaining market share in some areas such as computing. Credit Suisse expects the expansion of the Move concept stores will drive sales profitability, while the New Zealand turnaround is considered on track.

Nonetheless, further expansion of Dick Smith-branded stores elicits a cautious response from the broker from a returns perspective. A sustained improvement in sales, over and above cost inflation, is needed for the broker to become more comfortable. Moreover, a subdued consumer environment and mature product cycle are likely to cap growth and there is also a risk of manufacturers such as Apple and Samsung integrating their products over the longer term. At present, Credit Suisse considers the stock is fair value.

The company has used alternative channels and targeted customers offers as it strives to gain business, but CIMB notes sales productivity is well below larger rival JB Hi-Fi ((JBH)). Dick Smith expects to sustain a gross profit margin around 25.1%, which suggests to CIMB that pricing will remain aggressive. In anticipation of higher sales, the company has seemingly undertaken a large inventory build-up. Hence, there is a risk larger competitors intensify their activity to defend market share. Taking a conservative line, CIMB forecasts margins to be flat at this stage. The broker considers the valuation discount to peers is unjustified. There is scope for improvement and earnings growth in FY15 is likely to exceed peers. Despite this the stock trades at a 24% discount to Harvey Norman ((HVN)) and a 33% discount to JB Hi-Fi.

CIMB maintains an Add rating, assuming a discount of 30% to FY15 forecasts for the industrials multiple ex banks. This reflects the structural issues facing the retail sector and the risks around the cost elimination Dick Smith is attempting. The broker's target is $2.70, similar to Macquarie's. Both brokers have the Buy ratings on FNArena's database. The other rating is Credit Suisse's Neutral. Consensus target is $2.54, pulled down by Credit Suisse's $2.22, and suggests 14.9% upside to the last share price. Dividend yield on FY15 forecasts is 6.3% and on FY16 it is 6.4%.

Macquarie believes further delivery on growth forecasts and the establishment of a track record as a listed entity are needed to drive a re-rating. Macquarie expects a further reduction in the cost of doing business will be the key driver of margin improvement. FY15 should also reveal the benefits from the NZ restructuring and savings from Australian logistics following restructure of the Chullora distribution centre. The broker suspects that the substantial discount to other specialty retailers is mostly about the market's lack of confidence in the sustainability of a turnaround. To that end FY15 should provide more confidence and a cleaner result.

Citi is convinced Dick Smith is looking to take share from JB Hi-FI. Given both are often located in the same shopping centres the broker expects most of the competition in the electronics segment will be between the two. Growth may have been notable in FY14 but Citi believes the company is still way behind JB Hi-Fi, with sales and earnings per square metre less than half that of its major rival. Still, Dick Smith has shown a clear desire to win market share and attack high sales productivity categories such as mobiles and IT. UBS compares the two companies as well, and believes JB Hi-Fi needs to react to regain momentum in IT. The broker highlights a risk that JB Hi-Fi could lose price leadership in the market.
 

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