- JBH needs to boost flagging revenues
- Plans to trial home appliance expansion
- Not what analysts had in mind
- Scepticism reigns

By Greg Peel

Hands up who remembers Brashs? In the 1980s Brashs became the iconic, large chain, go-to music store during the vinyl-to-CD transition, as well as selling “browngood” stereos and so forth and (since 1862) musical instruments . By the 1990s, and boasting 105 stores, Brashs business started to get stale. Richard Branson moved into the space with a new, cool attitude. Smaller music stores offered the buyer a more personalised service. As music earnings growth faded, Brashs decided to expand its earnings base base with a shift into whitegoods. In 1995 Brashs went belly up owing $80 million.

JB Hi-Fi ((JBH)) had for several years been the darling of the consumer discretionary sector. Over the past decade JB transitioned from a basic browngood and CD retailer to a leading edge, youth attractive source of IT products – devices and software – and rode the technology revolution wave right through the GFC. JB confounded the market in posting consistent earnings growth and store roll-outs at a time when stalwart listed retailers were feeling the pinch of the consumer back-down.

Four years after the GFC, the consumer is yet to come back in earnest. In the meantime, it's JB's turn to go stale. The IT revolution has become mainstream, and attacks are coming from different fronts including that of more Apple stores. JB was where you first want to buy a smart phone before Apple opened locally. In response, JB has decided to expand its earnings base by moving into whitegoods and kitchen appliances.

Ask not for whom the bell tolls.

Unlike Brashs, nevertheless, JB is not making a costly commitment management may live to regret. The company had previously acquired Home Appliances chain Clive Anthony which was cheap but cheap for a very good reason. JB has not been able to turn that business around, possibly because the name has been retained and since further tainted by the Clive Peeters collapse. The company has already converted several into JB Hi-Fi stores but management's new plan is to take six of those remaining Clive Anthony stores and rebrand them as JB Hi-Fi HOME. 

It is a trial. If the trial works, then more HOME stores are on the cards. Interestingly, the six stores chosen are all in Queensland, and it is in the south east where Clive Anthony suffered most, from the effects of storms, floods, deserting tourists and economic downturn. The trial may prove quite an ordeal, but the good news is it's not really going to cost much. The stores are there, the inventory's there, all that's need is a new design and paint job and some sassy young JB staff to JB-ize the operation.

Retail analysts are relieved it is only a trial.

“While we are not surprised by the move into appliances (although large appliances is somewhat surprising), we believe it is unlikely to be the panacea,” says Deutsche Bank.

“A second attempt at entry into whitegoods retailing is likely to be value negative,” offers Credit Suisse.

“In our view, JB should be continuing to downscale out of these categories (where it doesn't have a leading edge), not expanding them,” says BA Merrill Lynch.

“The proposed JB Hi-Fi HOME trial has a low probability of success,” suggests CIMB Securities.

The problems these analysts foresee are varied, but fundamentally they take issue with brand and competition.

It's easy to be hip and cool when selling an iPhone to a twenty-something. Is it possible to be hip and cool selling a clothes dryer? Does JB's typical demographic, Gen Y, want to buy a clothes dryer? Would a BB/Gen Xer think of JB when looking to buy a clothes dryer? The risk is that the hip brand JB has built and exploited will be undermined and diluted by a more concerted shift towards a vanilla home appliance one-stop shop. Random? Totes.

Will existing JB staff, who have cut their teeth in electronics and IT, know where to begin to sell a front-load washing machine?

When one thinks washing machines or kitchen wizzes, one immediately trundles off to the nearest Harvey Norman ((HVN)) or feels the good vibrations and goes in to see the Good, Good, Good Guys. These two chains dominate the whitegood and home appliance space. And because they do, they enjoy significant volume rebates from major suppliers. The unlisted Good Guys fly more under the radar but we know that Gerry has been really struggling these past few years. If Gerry's having trouble shifting fridges on margins bolstered by volume rebates, how is JB, at higher landed prices, going to meaningfully compete?

JB couldn't turn around Clive Anthony. Will a new name and a lick of paint make the difference?

As noted, the above brokers are relieved JB is only trialling this idea, and that it really won't cost that much to do so. However, all brokers agree JB Hi-Fi needs to do something to revive its flagging earnings growth. To that end, not all analysts are quite so down on the HOME idea.

JP Morgan sees the HOME trial announcement as a positive, as it exposes JB to what the analysts describe as a “better” industry. If the trial is extended, it reduces some of the issues weighing on the company such as a modest revenue outlook, they believe. It will not be without risk of course, but for JPM is doesn't really matter that much anyway. The analysts don't see even a successful home appliances business as being able to offset the flagging fortunes of JB's core business. 

JP Morgan retains a sector Underweight.

UBS, on the other hand, has reiterated its Buy rating post announcement. It's not that UBS sees the trial as a smashing idea, it's more an acknowledgment that it will not require much in the way of working capital, will not require new leases, and will finally put Clive Anthony out of its misery, which can only be a positive.

CIMB has retained Buy, but the analysts are “concerned” about what signal with regard to JB's outlook this potential folly might be sending.

The bottom line is that JBH is a polarising stock for analysts. Indeed, one might say there is a level of polarisation surrounding the whole discretionary retail sector, with those looking at beaten down share price value on the one hand and those foreseeing the death of the traditional retailers and slow adaptors on the other. Currently the FNArena database shows UBS hanging on to Buy and CIMB qualifying a “concerned” Buy, while Macquarie (Outperform) has been quiet on the stock since August. JP Morgan, Credit Suisse and Citi all have Sell or equivalent ratings while Merrills and Deutsche are hedging with Hold ratings.

If we drop out Macquarie's fairly stale target pf $14.00, database targets range from Citi at $9.30 to Merrills at $11.20 for a consensus $10.24. That suggests about 3% upside at today's price.

The other factor to consider on the HOME front is, of course, what might JB's plans mean for Gerry? On the lack of excitement above, one might presume he will not lose too much sleep, however the Deutsche analysts think differently.

Deutsche has been the only database broker to date to offer a view on the impact of JB Hi-Fi's trial on Harvey Norman. The analysts believe that while HVN will continue to find support from the value of its property portfolio, the recent, apparent stabilisation of HVN's margins will now come under threat if JB decides to make its HOME presence known with a discount price war. They have put their forecasts where their mouths are and downgraded HVN forecast earnings by 8% in FY14, cut their target to $1.96 from $2.20, and downgraded to Hold from Buy.
 

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-Luxury brand expansion plans
-Strategy supported by brokers
-Long lead time problematic
-Penfolds asset not fully exploited
 

By Eva Brocklehurst

After a company presentation brokers were quite bubbly on Treasury Wine Estates ((TWE)). The part of the business that intrigues them is Penfolds, the originator of the famous 'Grange' tipple. Penfolds falls into the luxury wine category, which TWE is intent on expanding. TWE management has noted the majority of grape price volatility, historically, has been in commodity, commercial and lower-end wine products. Luxury wine grape prices have been far more stable due to the excess demand for these products in the market.

Macquarie has upgraded TWE to Hold, citing the the fact that Penfolds is one of the most profitable wine brands in the world. In fact, Macquarie suggests an in specie distribution to create The Penfolds Wine Company and estimates earnings could exceed $430m in five years. The broker values TWE at a pro forma $4.3 billion ($6.55 a share) and carves Penfolds out at $3.1bn. Macquarie's price target for TWE is a bit more grounded, at $5.75. The FNArena database has a consensus target price of $4.52. More on Macquarie's ideas a bit later.

Deutsche Bank analysts are a little more sober and have a price target of $4.30 and a Sell rating. They urge caution as, while conditions in the global industry are improving and TWE has a sensible strategy, the stock is fully valued and there is a substantial agricultural risk. Deutsche said the briefing served as a reminder that the profitability of TWE is highly dependent on agricultural variability at a number of levels - country, region, vineyard. This can impact both wine grape production yields and fruit quality, which affects the supply and cost of goods for premium wines. The risk is mitigated a bit by the fact that TWE's luxury wines are multi-region and not reliant on the grapes from a particular vineyard. The broker is also wary that returns on TWE's recent investments will take some time to be realised, given the maturity time lag and the fact that the projects are in anticipation of future demand.

TWE management noted in the presentation that "global supply is heading towards balance" and was positive on the long term prospects, given cycles in the wine industry have historically run for 7-10 years. Land under vine has been falling in Europe, consumption is growing and wine grape and bulk wine prices are rising globally. Global production of the 2012 vintage was at a 37-year low but this was reported to be as a result of weather-related issues in Europe, which will likely normalise next year. Yields in Australia have been low by historical standards, however, Deutsche is concerned that, if the supply/demand dynamics are improving globally and future growing conditions are favourable, a return to historical yields may lead to excess supply.

JP Morgan says the strategy in expanding its luxury wine production capability is sound, given the stronger returns generated in the category. However, this broker's concern is that the share price is factoring in more earnings growth in the short to medium term than is likely to be delivered, given the lead times involved. Additionally, the market is likely to be underestimating the required capital investment, and the balance sheet expansion that will occur in the next few years to pursue the luxury wine strategy. As a result, JP Morgan believes there are more attractive investments in the sector on a risk/return basis at present. Moreover, the broker contends, with the stock trading at $5.19, the Australian dollar would need to depreciate by around 20% against the USD, GBP and EUR from current levels for the stock to be fair value. While this is not impossible, it's not considered likely in the near term. JP Morgan's share price target is $3.80.

Macquarie, pursuing its thesis that TWE would be better off spinning out Penfolds, considers the market is pricing TWE for either a significant lift in earnings and/or a takeover. The broker has modelled earnings outcomes under the existing business model and cannot create consensus outcomes. TWE doesn't report brand business unit results but Macquarie estimates TWE is overly reliant on Penfolds, which accounts for around 5% of sales volume but 25% of gross profit. Macquarie says its FY13 numbers have been unchanged for six months, despite a 35% reduction in consensus estimates, yet it remains at the bottom of the market in earnings estimates for the next three years. Macquarie has therefore pondered the scarcity value in the Penfolds brand and how best to realise it. As Penfolds is a part of a mass market brand portfolio, its route to market is often hostage to distribution arrangements for other brands. Macquarie's conclusion: the best way to exploit Penfolds' scarcity value is to establish it as a separate luxury brand, led by a winemaker and distributed on a direct to consumer basis.

On the FNArena database TWE  is rated a Sell by JP Morgan, Deutsche Bank, Credit Suisse, Citi and UBS. Hold ratings are held by Macquarie and CIMB. BA-Merrill Lynch rates it a high risk Buy and tops the consensus target price range at $6.50. The bottom of that target range is $3.50, held by Citi and Credit Suisse.

See also Treasury Wine's FY13 Hangover on October 24 2012.

[Ed :1990, Southcorp acquires Penfolds; 2005, Foster's acquires Southcorp; 2010, Foster's spins off Southcorp (TWE); TWE to now spin off Penfolds? One might ask, what was the point of the last 22 years?]

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