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How Will JB Hi-Fi Fare Once Stimulus Ends?

Australia | Jun 12 2020

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

JB Hi-Fi has been in a plum position to benefit from households spending more time at home for both work and play, but how will this pan out once government stimulus ends?

-Net profit likely to fall in second half of FY21
-Could this be time to take profits in JB Hi-Fi?
-Have household expenditure trends changed?


By Eva Brocklehurst

JB Hi-Fi ((JBH)) has experienced an extraordinary run of sales as households spend more time at home, but the issue now lies with how much demand has been pulled forward as a result of the pandemic.

The share price has risen around 30% since early April, UBS notes, and subsequently the market has appreciated the earnings strength resulting from the pandemic, and the fact that liquidity concerns were unwarranted.

Yet, while JB Hi-Fi has a strong business model, the stock is trading on multiples at whcih UBS believes the risk/reward is just fair, and earnings risk is building because, after September 2020, government relief in the guise of JobKeeper and rent/loans to small-medium enterprises (SME) will end (unless there is a subsequent development).

Given the highly unusual market conditions as FY20 ends, Citi is therefore cautious about the outlook for FY21. The sales run-rate is likely to remain strong in the first quarter and support the first half but, looking through the spike stemming from working and learning from home, earnings should normalise in the second half and net profit fall -34% from a very high prior corresponding base.

Guidance is now for net profit of $325-330m in FY20 (adding back in the non-cash impairment for the NZ business), and well ahead of most forecasts. This implies more than 3x EBIT leverage, driven almost entirely via costs as the gross margin is likely to be flat, UBS asserts.

Guidance represents 30% growth on the prior year, converting to around 70% in terms of net profit, which emphasises incredibly strong operating leverage and an ability to control costs, and on this basis Morgans expects strong cash flow conversion will likely lead to a material reduction in net debt.

Product innovation could benefit the company in FY21, although the broker agrees earnings are likely to fall in the second half. Morgans is not unduly concerned and does not believe the market is capitalising FY20 earnings at "ridiculous" levels.

Sales were up 20% in the second half to May 31 for JB Hi-Fi Australia and up 23.5% for The Good Guys which suggests a market share loss to Harvey Norman ((HVN)) in electrical, Credit Suisse asserts.

The location of stores are likely to be the main cause of this, in the broker's view, given JB Hi-Fi's greater exposure in shopping centres and being overweight Victoria. Potentially, shopping centres could become less attractive retail locations for an extended period of time.

Profit Taking?

Credit Suisse advises taking some profits, given the second half has benefited significantly from households spending more time at home during the pandemic and the likelihood consumer expenditure will drop once government support packages cease

The stock may be "quality" but it is trading at a significant premium to peers and at the high end of historical multiples. Hence, the broker downgrades to Underperform from Neutral.

The broker accepts expenditure on entertainment and technical items is now considered "essential", and therefore exposed to a low income effect, but the usual correlation between house prices and household goods expenditure will now be lower over the next 12-18 months as a result of this behavioural change.

Moreover, a $25m impairment on the carrying value of the NZ business appears to be stemming from a weakened competitive position in New Zealand rather than pandemic-specific factors. New Zealand is not material to value and Credit Suisse believes it could be an opportunity to rethink the strategy. Ord Minnett suggests the NZ impairment provides a base for improved earnings in the near term and further options in the medium term.

Investment View

Morgans finds little to dislike about the investment case but anticipates it will be uphill for the stock in the second half of FY21 as a strong comparable period is cycled. Clearly, JB Hi-Fi has benefited from a large investment in the home office and a material step up in stimulus from tax write-offs for SMEs.

Macquarie has even fewer qualms, assessing JB Hi-Fi's ability to grow earnings at double the rate of sales in the midst of additional cleaning/security costs highlights the operating leverage in the business.

While acknowledging the outlook for discretionary expenditure after September is uncertain the broker suspects households are diverting travel expenditure to household goods and this should continue to some degree while borders are closed.

Ord Minnett is even more positive and upgrades to Accumulate from Hold. The broker believes a combination of product and channel/location should support the second half despite a tough comparable period. The broker likes the product mix which includes a sustainable advantage in entertainment and technology and also notes The Good Guys is performing better.

FNArena's database has two Buy ratings, four Hold and one Sell (Credit Suisse). The consensus target is $39.85, signalling just -0.9% downside to the last share price. Targets range from $34.52 (Credit Suisse) to $44.00 (UBS, Ord Minnett).

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