Australia | Feb 12 2013
-JB Hi-Fi results prove resilient
-Stock valuation now fair
-Concerns about sales growth
-Sustaining margin not enough
By Eva Brocklehurst
Specialty retailer JB Hi-Fi ((JBH)), ahead of reporting season, had become a litmus test for the retail sector. So, what are brokers interpreting from the company's first half earnings results, released yesterday? To some extent it depends on where they sat on the performance line beforehand. There's convergence towards the neutral or middle as the stock's recent rally fulfills expectations. The divergence is in outlook and depends on just how confident the broker is that this retailer can sail through the storms that continue to batter the sector. Macquarie remains the most gung ho on the FNArena database, the only one with a Buy rating, noting the stock is still trading at a discount to its peers. The company's 3% profit increase was close to Macquarie's forecasts and gross margins expanded as anticipated. Moreover, January's trading margins have improved. All-in-all, for Macquarie it was a competent result.
UBS called it a great result in a tough market. As the stock's valuation is now considered fair, UBS has downgraded to Hold from Buy. The broker takes a positive view that the sector is becoming more rational but emphasises any upside for the stock hinges on this. To be rational the company must clear inventory at a reasonable margin and maintain the momentum in new product launches. This broker heeds the company's note that it is holding an increased level of aged stock and that excess inventory is expected to be sold at full margin.
Deutsche Bank notes expectations for the stock had probably overshot on the downside ahead of the result and welcomes the improved margin. It's just that sales were not given the attention they deserved and they were not robust. The broker said sales growth of 2.3% was the weakest ever seen. On a like-for-like basis sales declined by 3.5% across JB Hi-Fi branded stores and 3.4% in Australia. Deutsche Bank poses the question of whether the company walked away from lower margin sales which could have had the effect of increasing profits but decreasing sales. This was denied by the CEO at the conference call so Deutsche Bank is a bit confused as to what's underpinning the weak sales growth. Moreover, headwinds persist in the sector, particularly with structurally challenged categories, and this is why this broker is sticking with its Hold recommendation.
CIMB is also taking the middle road. This broker remains concerned about the inventory turnover as it appears the company is using capital-intensive goods to drive sales. Specifically, there is increased inventory from funding private label expansion (Soniq and Yellowstone) and new categories such as musical instruments and white goods. CIMB maintains that, if the company decided to advance its white goods strategy even further, inventory turnover would move even lower. This could tie up the balance sheet and, potentially, limit the magnitude of future capital returns.
JP Morgan opted to upgrade its recommendation to Hold from Sell, because of earnings upgrades and a less demanding valuation. This broker admits it missed opportunities to get more upbeat about JB Hi-Fi, hence the upgrade. Nevertheless, it's not that euphoric, believing the cloudy earnings outlook and risk/reward do not justify a Buy. What prompted Credit Suisse to go the other way, downgrading its rating to Sell from Hold, was the strong relief rally in the stock post the result. This broker is mindful that underlying sales growth will remain low, dragged down by declining sales of software and the maturation in the audio visual category. Credit Suisse finds insufficient initiatives to predict a trend increase in gross margin to compensate for the slow top line growth.
Two others have a Sell rating on the FNArena database – Citi and BA-Merrill Lynch. Citi puts it bluntly. Near-term earnings have been protected by higher gross margins and a resumption in like-for-like sales growth is needed to improve the outlook. The broker expects continued weakness in sales to result in falling profit margins over the next three years. Moreover, Citi finds the company's inference that gross margins and like-for-like sales can grow at the same time difficult to accept. BA-ML frames its outlook for JB Hi-Fi as "buyer beware". The broker just doesn't like what it suspects is margin protection at the expense of sales growth, believing the value proposition of the stock is being eroded. Again, the summation is familiar: there's too many structural headwinds in this industry for the market to maintain a focus just on margins.
While the headline result came across as a positive surprise to the market, the fact that JBH was at that point the most highly shorted stock in the market provided an obvious short-covering boost within yesterday's 17% rally, clouding any simple re-rate. As it stands, the FNArena database now shows one Buy, three Hold and four Sell (or equivalent) ratings with a consensus target of $11.89, some 6% below the current traded price.
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