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JB Hi-Fi (ASX:JBH) and Super Retail Group (ASX:SUL) recently released their HY19 results. They were surprisingly strong, beating market expectations that have been progressively downgraded amid slumping national retail sales and foot traffic numbers. The question for investors is: how long can they defy the retail gloom? Continue…

by Roger Montgomery Posted in Companies.

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What a difference a high Australian dollar (lots of people travelling and spending their money overseas and not here), a shift to online retailing, deflation, competitors going out of business, higher petrol prices and a more cautious consumer can make in the retail space in just nine months. And few companies are more exposed to all these influences than JB Hi-Fi.

Back in August 2011, the company reported the following in their annual report;

FY11 Sales $2.96b

FY11 NPAT $134.4m

FY11 NPAT Margin 4.5%

Based on these numbers as well as company guidance for sales growth in FY12 of 8% to $3.2b, the consensus analyst view at the time was for 11% FY12 NPAT growth to $150m.

Since that time however, shareholders have suffered three profit downgrades – in mid December, mid February and another this morning.

In this morning’s trading update, management have guided analysts to an estimated NPAT of $100-$105m on sales of $3.1b. Based on this latest announcement, 2012 numbers will look like this (assuming no further downgrades);

FY12 Sales $3.10b

FY12 NPAT $102.5m

FY12 NPAT Margin 3.3%

What’s clear from these numbers is that sales revenue is growing. No immediate issues there. And despite being below the initial 8% forecast, sales are now forecast to grow by 5%. The concern however is that LFL (like-for-like) sales are negative. For the nine months, sales of mature (older established stores) are down 1.3% which means without their current expansion plans, sales targets would not be met. It’s also the main reason their initial 8% sales growth target won’t be met.

But the main issue in forecasting what the business is worth is that despite this incremental sales growth, this is not CURRENTLY being converted to the bottom line. Based on management’s forecasts, NPAT margins will be 3.3% this year vs. 4.5% in the year prior, a 26.7% margin decline in just nine months. No businesses can increase intrinsic value in such an environment.

The tide that’s currently running against JBH is very strong, no plaudits for pointing that out. But when that tide turns, could JB Hi Fi be in an even better position than it was going into the non-resource-recession (a.k.a. the seven cylinder recession of 2012). There’s certainly the possibility and the key is working out when the economy turns and whether the structural changes occurring in retail are enough to adversely impact and offset the benefits of a cyclical turnaround.

Here’s what we are watching:

· Recently management including CEO Terry Smart and Chairman Patrick Elliot have been heavy sellers of their own personal holdings in JBH. What do they know? Why are they selling?

· The retail industry is experiencing a huge shake-up. Many retailers are doing it tough and many more are exciting the space. The Good Guys was being shopped around for a private sale recently with Blackstone rumoured to be the suitor. Later denied by them. Clive Peters (now owned by JBH) and WOW Sight and Sound have gone into receivership and JB’s largest competitor Dick Smith (owned by Woolies) is set to close 100 stores by 2014. Few electronic retailser are investing in growth. The night is darkest just before the dawn so we are looking for evidence that JB Hi Fi is capturing market share in such an environment, either by making acquisitions of distressed sub-scale business or by taking over leases in locations previously unavailable to them. In QLD it appears up to $250m in sales are up for grabs as competitors close. Dick Smiths had $1.5b in sales of which an optimistic analyst would say that JBH could pick up a substantial portion of.

· Currently electronic retailers are on the back foot evidenced by store closures and liquidation sales. These participants are forced sellers of excess stock putting HUGE downward pressure on retail prices and hence profit margins. In March alone, JBH experienced a 200 bps contraction in gross margins. I was silly enough to buy two C3-PO USB keys for my kids at Christmas for $40 each but picked up another two in Brisbane a few weeks ago for $18 at a closing down Dick Smiths (my new book will be called How to Go Broke Saving MoneyTM).

Margin compression of the magnitude reported recently is unprecedented for an operator of JBH’s buying power. So we are looking for signs that the worst is over in terms of competitors closing their doors, a sure sign margins will improve or cease falling precipitously.

· We are also watching closely JBH’s move into the online space. Growth has been excellent in this segment of the business (admittedly off a low base) with an average of 965,000 website visitors each week. That’s 50.2m views per annum – 2.4 times the population of Australia. The trick of course is to convert page views to sales.

· In prior years the business has benefited immensely from positive LFL sales and also an internally funded store-rollout strategy driving new sales and sales as stores matured. This was a tailwind for the business when the number of new stores being added divided by existing stores produced a high ratio. For example when the business only had 50 stores and another 15 were opened, the proportion of stores growing and adding to sales was 30%. At present the business has in excess of 150 stores and is opening 14-15 stores per annum – a ratio of just 10% in new growth. So when you have negative LFL sales in existing and maturing stores, this is a huge drag on business momentum. We are therefore watching for signs that LFL sales stabilise or turn positive so that the business gets its mojo back.

We think it can although we are convinced the very easy money from the store roll out stage of the business along with P/E expansion has been made. Businesses with a leading market position are able to survive traumatic periods in what is a highly cyclical business and are able to absorb the effects of margin compression. Provided they can capture high levels of market share amid the tumult and cement their position as the dominant player JBH might be well positioned for the next economic recovery. One might ask whether ‘Terry and Co’ will be there when that happens.

Skaffold.com Intrinsic Value 13 year chart.

by Roger Montgomery Posted in Consumer discretionary, Skaffold.

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Here we are in the midst of reporting season and there are some reasonably predictable results. Qantas reported a profit today that was less than a quarter of its profit more than ten years ago. The airline reported a $112 million profit but that was boosted by $1 billion of revenue from its Frequent Flyer program and a $300 reduction in employment costs. For those of you interested in the real numbers, the company actually lost $302 million (see my chapter in Value.able on cash flow) and this can be explained by the very wide gap between the depreciation item in the profit and loss statement and the real expenditure on property plant & equipment. Depreciation looks backwards, but new planes cost more.

Separately, JB Hi-Fi’s result was excellent but my concern is that its $94 million of cash flow (of which $67 million was allocated to dividends and $20 million allocated to paying down debt) is superfluous to its needs. Take a look at the biggest asset on the balance sheet – Inventory of $334 million. Then take a look at the creditors item in the current liabilities section. Almost the same amount!

Think about it this way; the suppliers are funding the inventory so the company doesn’t even need cash to pay have the stuff it sells and that are on its shelves. Actually it really does, the gap is about what is left over once we subtract the debt repayment and dividends from the cash flow. It is small though. Once the debt is gone and the cash keeps growing it may do something that could harm intrinsic value.

Now don’t get me wrong; JB Hi-Fi is an amazing business that retained its A1 status in this result and the risk associated with its plans to roll out more stores is very low. I also think intrinsic value will continue to rise at a satisfactory rate. The concern for me with all this cash (and there is no evidence of it yet) is that the company increases the dividend payout ratio again. This would mean a reduction in the rate of growth of intrinsic value. It could stop being the “compounding machine” it has been to date. Return on equity also appears to be flattening, which could mean within the next few years, the valuation may plateau (but at a higher level than the current price).

On an unrelated issue, I note that back on 4 May 2010, I put together a list of the companies that I though represented the last of value in a blog post entitled Do these three companies represent the last of good value? ITX was one of the companies listed and I note the company has announced “itX confirms that it is in discussions with an interested party regarding a preliminary non-binding indication of interest to acquire 100% of the ordinary shares in itX.”

I’m pleased to strike another one up for the quality rating and valuation approach advocated here at my Insights blog!

Posted by Roger Montgomery, 12 August 2010

by Roger Montgomery Posted in Airlines, Companies, Insightful Insights.

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Roger Montgomery joins Peter Switzer to discuss two of Australia’s most well-known retailing businesses — Harvey Norman (HVN) and JB Hi-Fi (JBH). Whilst Roger considers Gerry Harvey to be a retailing genius, Roger says JB Hi-Fi does a better job selling the same products in the same market. So is JBH a buy? What is its forecast 2012 intrinsic value? And can Terry Smart continue the market-beating success of former CEO Richard Uechtritz? Watch the interview.

by Roger Montgomery Posted in Media Room, TV Appearances.

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AGL, like Origin Energy and Arrow, has been expensive for a long time. According to Roger Montgomery this seems to be a general trend in the energy sector. In his appearance on Nina May’s Your Money Your Call Roger also reveals his 2010, 2011 and 2012 valuations for Bluescope and JB Hi-Fi, and discusses the impact of management’s decision to raise JBH’s dividend payout ratio from 50% to 60%. Watch the interview.

by Roger Montgomery Posted in Media Room, TV Appearances.

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The retailer’s same-store and overall sales were strong, it is dominating its sector and its prospects are bright.

by Roger Montgomery Posted in On the Internet.

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