JB Hi-Fi Prioritises Chase For Sales Growth

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

The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

JB Hi-Fi has stated intentions of chasing sales and market share at the expense of gross margins. Brokers diverge on the degree of success anticipated over the next several years.

-$20m synergy buffer spread over FY18 and FY19 for further price investment
-Seen taking advantage of strong demand to position the business competitively
-Macro and competitive headwinds may limit scope for outperformance
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) found support from the Australian consumer in the first half, and the degree of strength in several categories of discretionary retail, including electricals, surprised brokers. There was some margin erosion. JB Hi-Fi Australia delivered a better outcome while The Good Guys fell short of expectations.

The company intends to grow sales and market share at the expense of gross margin, which is considered a reflection of the highly competitive environment. Gross margins fell by 20 basis points in the first half. The sales mix could no longer be offset by better buying terms and category management, as Citi notes has been the case for the past five years.

As a result of the company's clear desire to chase sales, the broker increases its growth estimates for JB Hi-Fi Australia to 4.4% in the second half and 3.5% in FY19. In contrast, sales growth estimates for The Good Guys are reduced to flat in the second half and 2.0% in the FY19.

Cost growth has also accelerated and earnings risks are yet to be fully reflected in the share price, and Citi continues to envisage downside risks as margin pressures build, sustaining a Sell rating.

Although gross margin pressure was evident, JB Hi-Fi has reiterated $20m of synergies, spread evenly over FY18 and FY19, providing a buffer of 28 basis points in FY19 sales estimates for further price investment, on Macquarie's calculations.

The broker also anticipates the quantum of synergies available can be revised higher ahead of this. FY18 net profit guidance of $235-240m was provided for the first time. Macquarie suggests guidance is conservative and the stock valuation undemanding, given the recent trends in synergy benefits.

JB Hi-Fi continues to be a sales-led organisation, Deutsche Bank agrees, and does not have an issue with the business re-investing its operating leverage and synergies into price and service, suggesting it is sensible to take advantage of strong demand to better position for when things may be more difficult.

UBS believes the company is one of the best consumer electronics retail models globally but there is limited scope for earnings growth on a three-year view. This is because of exposure to this successful category at Amazon, and a weaker consumer that has to contend with rising living costs and weak wages growth.

A continued fall in the savings rate is required to sustain current spending growth rates, the broker asserts. While the stock's valuation is not demanding, UBS maintains a Neutral rating, believing the macro and competitive headwinds will limit scope for outperformance.

Ord Minnett points out the Amazon launch in Australia has been underwhelming on price, range and product mix so far and JB Hi-Fi appears to have responded to the competitive threat better than expected, with investment in online fulfilment allowing for same-day delivery and click & collect.

Morgans agrees that investing to maintain price/market leadership is the right move and the company has a synergy component to buffer the impact of Amazon in a competitive environment.

The Good Guys

Although the cycling of seasonal product strength in January was noted (air conditioning), Macquarie suggests weakness at The Good Guys was broader based and included the impact from a change of management following the acquisition. Industry feedback suggests the chain was investing in price to generate sales.

Given the synergies and relatively low EBIT (operating earnings) margin Morgan Stanley envisages scope for growth at The Good Guys and considers concerns misplaced. It will take time to implement system changes and adapt to new personnel as well as reduce the reliance on eBay for online sales.

Credit Suisse wants more clarity on The Good Guys following the expenditure of $800m on the acquisition, noting JB Hi-Fi does not have a successful track record in large appliances.

The broker acknowledges the company has only owned the business for nine months but, if decelerating sales represent a re-positioning of the brand, asserts it would be helpful to understand if there is improvement in transactions.

Credit Suisse recalls, despite The Good Guy's being a far different business in terms of scale, that JB Hi-Fi advised the market that large appliances were very important to improving profit in New Zealand.

Weakness at The Good Guys may be of concern but Deutsche Bank notes it is early days and management's strategy appears sensible. The broker suspects the company took market share from Harvey Norman ((HVN)) in some categories.

This may have been offset by Harvey Norman gaining share from The Good Guys. Commentary has prompted the broker, nonetheless, to incorporate a modest downgrade to estimates.

Morgans believes the main sensitivity regarding whether the company achieves the top end of guidance is the achieved gross margin in the second half, and in this regard gross margin at The Good Guys will also be a key determinant.

Credit Suisse has an Underperform rating and maintains an expectation of a high levels of price deflation and market share loss over the medium term and suspects it will be the differing margin expectations the drive the varied market views.

Morgan Stanley is at the other end of the spectrum, with an Overweight rating, finding the current valuation to cheap, given the high single-digit growth outlook. The broker notes guidance has erred on the conservative side since FY12.

Remarks regarding sales growth exceeding gross profit growth are more linked to the relatively healthy outlook in low-margin categories, such as telecoms, computing and games hardware, versus an expected increase in industry competitive intensity, in the broker's view.

Morgan Stanley believes a strong market position and more scope for share gains from department stores signals the market has been punishing the stock unnecessarily.

FNArena's database shows four Buy ratings, two Hold and two Sell. The consensus target is $27.48, suggesting 5.8% upside to the last share price. Targets range from $21.20 (Citi) to $32.00 (Morgan Stanley) the dividend yield on FY18 and FY19 forecasts is 5.2% and 5.4% respectively.

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