Since listing in October 2003, JB Hi-Fi has left analysts and shareholders spellbound by the impact of its extraordinary returns on equity. As you know, the Value.able magic began to fade for me late last year.
Why? Well JB Hi-Fi’s business appears to be maturing. And there are only so many stores you can put on an island!
No matter where you live in Australia, and no matter which shopping centre you walk into, you will never be too far from a JBH store – music blaring behind trademark billboard style placards screaming for your attention.
Yes, there are more stores in the pipeline (currently 153 with a target of 210). At an opening rate of 15 stores a year, that implies another 4.5 years of growth. But will the new stores be as profitable as the existing ones?
Retailers often have two, if not more, ‘Tiers’ of stores and JBH is no different. Of its target of 210 stores, 160 will be Tier-1 and 50 will be Tier-2. Tier-1 stores cost $2.5 million to set up, while Tier-2 are 20% cheaper. But Tier-2 stores generate only 70% of the revenue of a Tier-1 store.
Of the 67 stores yet to open, 31 will be Tier-2. That’s half of JBH’s newest stores less profitable! Currently Tier-2 stores account for just 13 per cent of JBH’s business.
JBH has $180 million sitting idle in the bank. With growth on the horizon, suppliers covering the cost of goods, high margins and low net debt, management’s decision earlier this year to review its capital management policy didn’t come as a surprise.
As we enter the first month of Autumn, the Chairman will no doubt be preparing to reveal the results of this review.
Whatever the company’s initiatives – buy back shares, return capital or increase the dividend payout ratio – the actions will have a material impact on my Value.able estimate of JBH’s value.
With that in mind, I would like you consider which is more valuable… one dollar in a bank account earning 45% and that figure compounds at 45% year after year, or one dollar in a bank account earning 45% and that figure is paid out in dividends each year?
If you’re a Value.able graduate, I’m certain you know the answer.
The first bank account is more valuable, and that’s precisely why any changes in JB Hi-Fi’s capital management policies will have a material impact on its Value.able value.
If JBH buys back shares (a disaster if management did that at a price higher than what the shares are worth) or lifts its dividend payout ratio, then my estimate of intrinsic value will decline.
Business maturity is generally accompanied by a leveling off of intrinsic value (followed by a serious drag if a silly acquisition is made).
Watch for how JBH reports its profit. Has return on equity stabilised, or will it continue to rise? Will your estimate of JBH’s Value.able intrinsic value continue to rise?
Whist JBH remains one of my preferred retailers, I am less optimistic it will continue to generate the returns on equity shareholders have enjoyed over the past. What are your thoughts? Feel free to chat here about other retailers too.
Posted by Roger Montgomery, author and fund manager, 3 March 2011.
