Mixed Views As JB Hi-Fi Takes On The Good Guys

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JB Hi-Fi will acquire The Good Guys in a highly anticipated move expected to make the group the dominant player in the white goods and electrical retailing sector.

-Synergies forecast at $15-20m over three years are lighter than expected
-Potential for increased scale and buying power impresses brokers
-Risks in the unwinding of The Good Guys joint venture stores and combining business cultures
 

By Eva Brocklehurst

In a well-anticipated deal, JB Hi-Fi ((JBH)) has announced the acquisition of white goods and electrical retailer The Good Guys for $870m. The combined group is expected to become a dominant player in an industry brokers believe remains rational and sales momentum strong. That said, there is some unease regarding the risks of successfully coupling the two businesses.

Deutsche Bank was pleased that the price was based on trailing earnings and JB Hi-Fi did not stump up payments for growth that the vendor was simply expecting. JB Hi-Fi has guided to sales and earnings at The Good Guys in FY17 to be in line with FY16. The acquisition will be funded by $394m in a fully underwritten, pro-rata, accelerated, renounceable entitlement offer, with the balance through debt facilities.

The broker is concerned that the housing tailwind may have eased by the time the business is fully integrated. While the company intends to integrate over a period – outlining $15-20m in synergies to be achieved over three years – which lessens execution risk, Deutsche Bank believes this reduces the actual synergies entailed.

UBS estimates around 8% of JB Hi-Fi's sales are linked directly to housing and the share price has a 56% correlation with approvals. The broker expects housing to be supportive over 2016 before slowing in 2017.

Several brokers upgraded on the news, UBS raised its rating to Buy from Neutral, assuming in its forecasts a three-year compound sales growth rate of 3% and synergies of $17m by FY19. The broker expects the acquisition will provide upside risk to forecasts via synergy upside and a more rational market, given over the past 12 months the top four players have consolidated into two (with the demise of Dick Smith and now this merger). Harvey Norman ((HVN)) is the other player.

The deal impresses Morgans by virtue of the earnings accretion and power of the combined group's increased scale. While acknowledging the risks associated with the unwinding of The Good Guys' joint venture stores, the broker believes JB Hi-Fi management has appropriately allowed for the challenges. JB Hi-Fi's store footprint will increase by 52%.

The Good Guys consolidated 55 of its JV stores by July 1 and 30 partners have retired while the remaining 25 have stayed on as store managers. Based on a relatively undemanding FY18 price/earnings ratio over 10% upside to the price target, Morgans upgrades to Add from Hold.

Morgan Stanley takes a similar stance to Deutsche Bank, sticking with its Equal-weight rating, believing the critical issue of integrating two very different retail cultures will have its challenges. The broker observes The Good Guys to be a high cost, high service retailer compared with JB Hi-Fi's, low cost, low service model. The broker also remains concerned about the performance of The Good Guys following the joint venture partner's transition as well as the longer-term outlook for the business.

Morgan Stanley estimates 12% accretion to FY18 earnings per share should the acquisition proceed. JB Hi-Fi has advised that for the year to August 2016, comparable sales growth slowed to 7.7% from 9.5% in July and has suggested that the closure of Dick Smith will positively impact sales during the first half.

Citi believes the acquisition has been made at a fair multiple for a rare opportunity to consolidate the industry, yet the synergy target appears light. The broker had forecast around $40m in synergies. The lack of organic sales and earnings growth in FY17 estimates for The Good Guys may surprise on the downside, the broker believes, as the transition to corporatised stores is likely to be a headwind.

The company may look to extract further synergies if the operating environment deteriorates, the broker acknowledges, with the ability to consolidate support offices and generate cost savings. Both businesses are considered to be trading at or near their peak in terms of sales and growth. Still, the acquisition has been factored into the share price for several months, Citi concludes, and sticks with a Sell rating.

Credit Suisse views the transaction, with the brands to be run independently, as a portfolio acquisition, with the value being in the growth option and shared capability over the longer term. While the grouping is likely to offer supply chain and systems synergies over time, and be complementary with product access and promotional buying opportunities, the broker is concerned about the financial assumptions underlying the integrating of the joint venture operations.

This concern is in respect of the base EBIT (earnings before interest and tax) for the Good Guys. The broker notes large increases in EBIT in FY15 and FY16 and then flat guidance in FY17, with no disclosure of leases and low fixed assets in the balance sheet.

The deal is logical in terms of strategy, Goldman Sachs believes, and the enhanced scale should provide opportunities to improve buying terms. The broker, not one of the eight monitored daily on the FNArena database, does not incorporate the acquisition or capital raising into earnings forecasts at this stage and retains a Neutral rating.

Ord Minnett is one of the upgraders, moving to Accumulate from Hold. The broker believes the acquisition provides valuation support for JB Hi-Fi, and while there are execution risks, remains confident the process can be well managed, with the maintenance of separate head offices and cultures. Moreover, operating performance in both the second half of FY16 and into FY17 as been strong, delivering sales growth and EBIT margin expansion.

FNArena's database shows three Buy, two Hold and two Sell ratings. The consensus target is $29.51, suggesting 2.3% upside to the last share price. This compares with $27.50 ahead of the announcement. Targets range from $25.21 (Credit Suisse) to $32.55 (Morgans).
 

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