The Good Guys Weigh On JB Hi-Fi

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A competitive environment has weighed on home appliances, affecting The Good Guys, and JB Hi-Fi reduces its profit outlook for this division.

-Brokers disappointed with the downgrade given prior confidence
-Maintaining market share likely to come at a cost with respect to margin
-Slowing housing market may have further downside implications for The Good Guys
 

By Eva Brocklehurst

JB Hi-Fi ((JBH)) has downgraded FY18 net profit guidance by -2-4%, driven by the competitive environment in home appliances that has weighed on The Good Guys, seemingly setting aside expectations that acquisition synergies would address industry challenges.

Citi finds the timing surprising, given the seasonally quiet period of March and April. The broker's earnings estimates for The Good Guys are reduced by -50% for the second half, as the business invests in price and sacrifices gross margins amid a sales decline. Meanwhile, the JB Hi-Fi business is performing well and Citi forecasts 11% earnings growth.

While underlying net profit guidance has been lowered to $230m from the $235-240m guided to previously, the company has reaffirmed sales guidance of $6.85bn, comprised of $4.75bn from JB Hi-Fi and $2.1bn from The Good Guys.

Ord Minnett is disappointed by the downgrade, given previous confidence that the risk to earnings was skewed to the upside and there was potential for a larger pool of synergies from The Good Guys.

While the home appliances industry is challenged, the broker still finds reasons to be positive at the current share price, including a robust consumer outlook, and amid suspicions that the launch of Amazon was underwhelming versus an impressive response from JB Hi-Fi.

UBS continues to believe JB Hi-Fi is one of the best electronics retailers globally, characterised by its sales productivity, low costs and ability to adapt to change. Nevertheless, the broker acknowledges headwinds are increasing and maintaining market share will likely come at a cost with respect to margin, as was evident in this update.

Morgan Stanley, on the other hand, asserts that guidance implies compression in gross margin of around 390 basis points for The Good Guys in the second half that should reverse as competition eases.

Competitive Pressures

The rate of reinvestment in The Good Guys has stepped up and Citi considers the irrational pricing behaviour to be driven by a desire by both JB Hi-Fi and Harvey Norman ((HVN)) to gain market share ahead of Amazon developing a significant presence in Australia, in order to drive sales momentum despite the slowing demand.

Such behaviour tends to be cyclical and currently the broker envisages risks weighted to the downside because of a housing slowdown, the Amazon disruption and a falling Australian dollar, which will force manufacturers to increase prices. Citi considers the outlook for the electronics industry profitability is weak and maintains a Sell rating.

Ord Minnett suggests Harvey Norman is likely to be the aggressor in the market, benefiting from operating diversity and range. The broker acknowledges the synergies from The Good Guys may be less able to assist JB Hi-Fi in a challenging environment and may not be as large as formerly expected, asserting that business improvement measures are now more urgent.

Margin weakness at The Good Guys was deeper than anticipated but Macquarie believes the multi-year merger synergy tailwind and sales drivers should support sustainable earnings growth.

Harvey Norman

Deutsche Bank agrees Harvey Norman is giving The Good Guys a hard time, capitalising on the disruption that is stemming from the changing ownership to JB Hi-Fi, in order to gain market share.

The broker does not believe this behaviour will cease any time soon but retains a Buy rating for JB Hi-Fi because of the depressed valuation and strength in the JB Hi-Fi brand.

As Harvey Norman has control of the situation Deutsche Bank prefers this exposure to the sector, underpinned by that company's lower multiple, strong property backing and a product and customer mix that is less susceptible to the online disruptions.

Assuming almost the entire downgrade is being driven by The Good Guys, the broker acknowledges the pressure on gross margins means the business will fall well short of expectations and its FY16 result, the last result prior to the acquisition.

Morgans contends that in what can only be described as an uncertain competitive environment, a slowing housing market may have further downside implications for The Good Guys in the months ahead.

FNArena's database shows four Buy ratings, two Hold and two Sell. The consensus target is $25.82, signalling 9.5% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 5.6% and 5.7% respectively. Targets range from $20.50 (Citi) to $32.00 (Morgan Stanley).

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