Sales Up For JB Hi-Fi But What About Margins?

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

-Overall sales trend improving
-Price deflation eases for now
-Will gross margins hold up?
-Higher margin sales and scale are key
 

By Eva Brocklehurst

It's all about discounting in retailing these days. In a highly competitive environment how much margin-crushing discounting can be avoided? In the case of electronic – and recently home – goods retailer, JB Hi-Fi ((JBH)), what's ahead for margins makes or breaks a good report.

JB Hi-Fi reported an 11.2% increase in FY13 profit and declared a 22c final dividend. Sales rose by 5.8% to $3.3 billion. Gross margins increased by 43 basis points to 21.5%. So far so good. Cost of doing business as a percentage of sales increased to 15.1% from 14.9%, not so good. Like-for-like sales eased back 0.6% over the year. Not good. The improvement in first half gross margins expanded into the second half as positive comparatives contributed to the numbers. Margin expansion seemed to be reflecting better prices rather than the mix of sales, in Macquarie's view. Will it last? Price is still a major focus for the company but depth and frequency of price deflation has slowed, for the time being.

Traditional categories are still underperforming. Australian visual sales were down 11.9% and software down 2.6%. New sources of revenue were from online and digital channels and products from the new HOME segment. Online sale are now around 2% of sales. There's still some way to go for these new categories, in Macquarie's view. Management expects 6-8% revenue growth in FY14 but home and digital strategies might require more time to generate earnings growth. Macquarie thinks all the positives are factored into the share price now, anyway, and has decided it's time to downgrade to a more Neutral view on the stock.

UBS takes a different tack, believing the stock is well placed to outperform in the medium term. This is reflective of  the forecast earnings and good inventory and cost control. Sales momentum is also improving in growth categories such as telecommunications and seen stabilising in visual segments. Guidance includes contributions from online, commercial and home and UBS, adjusting for this guidance, finds this implies like-for-like growth of 0-2%. This may be light but the broker thinks it could prove conservative because of new gaming releases and improving trends in audio visual software, as well as rising prices. UBS notes the trial of the HOME store format has proven successful in delivering incremental sales and there's been no negative impact on the existing offering.

Citi retains a Sell rating. The company may have restored its growth trajectory and stepped up the focus on sales but the broker thinks there will be some gross margin erosion as lower margin categories drive overall growth. Pressure from competitors will continue to feature, given the high sales productivity of the JB Hi-Fi stores. For Citi, it's about lower long-run earnings margins. Margins are expected to drop 170 basis points over the next four years as growth in sales per store fails to keep up with the growth in costs per store. What stands JB Hi-Fi in better stead in this regard is that, at a long-run margin of 3.8%, the earnings per square metre for JB Hi-Fi is still higher than any other discretionary retailer under the broker's coverage because of the sales productivity per store.

As the company has made it clear the focus is on sales, not margins, Citi thinks there will be a negative mix impacting on FY14. Accelerating cost growth will also be a challenge as staffing and contracted lease costs are growing 3-4% per store – a problem when comparable store sales growth is less than 3%. Other negatives in the mix for FY14 are the more costly gaming consoles, where margins are less than 10%. This may be improved by attached software but it's still a low margin category. Software categories such as CDs and DVDs are nearer to a 30% gross margin and the decline in sales of these categories in FY13 hurts. What's positive on Citi's score card? Increased scale. JB Hi-Fi is a top retailer in computers and has a growing share of other sectors. It can squeeze suppliers harder. The other is reduced discounting activity, given the rumours that Dick Smith Electronics may be up for public offer.

Compression of gross margins is the concern for JP Morgan as well. Sales trends may be improving and, importantly, profits but the medium term outlook for margins worries this broker, as a result of changes in the sales mix and the industry challenges. The long-term sustainability of like-for-like sale growth is questioned because underlying growth is soft. It's not enough to change JP Morgan's viewpoint (Neutral) while earnings momentum is improving. Yet.

On the FNArena database the consensus target price of $16.75, signalling 11.4% downside to the last share price, compares with $15.20 ahead of the results. There are two Buy, three Hold and three Sell ratings. On FY14 consensus earnings estimates the dividend yield is 4.0%, on FY15 it is 4.2%.
 

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