Harvey Norman Update Highlights Weak Consumer Outlook

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This story features HARVEY NORMAN HOLDINGS LIMITED.
For more info SHARE ANALYSIS: HVN
The company is included in ASX200, ASX300 and ALL-ORDS

By Chris Shaw

With the Australian economy continuing to display signs of weakness, consumer sentiment also remains very poor and evidence of this is obvious in the struggles of retailers. Retailers of big ticket items such as flat screen TVs and furniture are particularly feeling the pinch.

To confirm just how tough market conditions are, Harvey Norman ((HVN)) has posted an update on both sales and profitability showing things are much worse than the market had expected. This will have serious consequences for earnings, as Citi notes the company is fixing its attention at present on retaining market share rather than maintaining margins.

As evidence of this, the broker points out September quarter profit fell 31% to $71 million despite a 1.3% increase in like-for-like sales. The broker notes the need for the company to clear inventory, which leads it to suggest a similar outcome in the December quarter. This sees the broker suggesting the company will generate a half year profit decline of 28%, though it takes the view 1H09 earnings should prove to be the weakest period in the cycle. Earnings in the second half should only be down by around 9%.

One issue according to ABN Amro is that the focus on retaining market share is pressuring franchise margins, which is likely to see the company offer some financial support to its franchises in coming months. It will also likely necessitate an increased level of support, a level greater than that in previous periods of economic weakness. As well, consumer financing is proving to be only of limited success in encouraging households to continue spending, so there are few obvious catalysts at present to drive any turnaround in the business.

The broker also notes attempts to offset this domestic weakness via international expansion are proving to be of only limited success, as the performance of the group’s Irish operations is worsening as it also suffers from a weak domestic economy. With earnings under pressure and with cap rates on properties trending higher, there is now less scope for revaluations as well, which the broker suggests is likely to put dividends under pressure.

Any recovery in earnings is likely to be relatively modest, as the broker’s forecasts call for earnings per share (EPS) of 22.1c in FY09 and 24.2c in FY10. Macquarie is even more bearish, forecasting EPS over the next two years of 19.2c and 19.7c. The broker’s view is based on doubts households can continue to consume at current levels given what are very high levels of household debt.

UBS has taken 17.5% from its forecast for FY09 and 19.3% from FY10 in lowering its EPS estimates to 20c and 23c respectively. The broker also cautions earnings risk remains to the downside at present. The FNArena database shows consensus earnings estimates of 22.7c for FY09 and 23.7c for FY10, though it must be noted not all brokers to cover the stock have adjusted their estimates on the back of yesterday’s update.

While the company continues to enjoy market leading positions in the industry and is well placed to expand when conditions improve in the current environment, ABN Amro suggests the stock should trade in line with the previous downturn of 2005 when it was on a relative P/E (price to earnings ratio) discount of 20% to the broader market.

To reflect this, the broker has set its price target at $2.35 and stays with its Hold rating. Macquarie rates the stock as Underperform, but has a higher price target of $3.03 on the shares. Overall, the FNArena database shows a total of two Buys, five Holds and one Sell, with an average target of $2.77. This is down from $3.19 prior to the first quarter update.

Today, shares in Harvey Norman are slightly stronger despite a weaker overall market and as at 2.30pm the stock was up 2c at $2.26. This compares to a trading range over the past 12 months of $2.05 to $7.25.

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