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Value.able TV#4: What did Roger Montgomery find out about JB Hi-Fi?

TV Appearances | Comments (46)

Value.able TV#4: What did Roger Montgomery find out about JB Hi-Fi?

Following the release of their full year results, Roger spoke with senior management at JB Hi-Fi and discussed their cashflow and working capital.

 

JB Hi-Fi scores an A3 (down from A1) thanks to a debt-funded buy back of shares. It is nonetheless a company with great cash flow. Value.able Graduates paying close attention to Cashflow in JBH’s latest result may have been concerned by the large jump in inventory, which had a detrimental impact on Cashflow from Operations since last year.

So, what did Roger discover?

In 2010 JBH stores were cycling low inventory numbers. Arguably this resulted in a sell-out of stock, which was due to under-provisioning,

Stepping back and looking over time at a pre-store level, Roger says “If you have a look at the inventory on a per store basis, $2.2m – $2.6m per year, it’s fairly consistent. I’m not concerned.”

Roger suggests the future is interesting for JB Hi-Fi. If store growth continues at the current rate (13-16 stores per year) for the next three to four years, then by the time they reach 214 stores, there will be a lot of free cash. Extra cash from the maturity of existing stores, combined with a reduction in debt, will see a very cash rich JBH.

What will management do with the extra cash?

In Roger’s view, management have three options: increase dividends, buy back more shares or make a [silly] acquisition.

Roger’s estimate of JBH’s Value.able intrinsic value in 2012 is around $17, rising to $20 by 2013.

Will intrinsic value continue to rise after that?

“That will be largely dependent on what management does with that cashflow when it’s freed up” Says Roger, noting; “I think the future for JB Hi-Fi will prove to be a didactic experience for value investors.”

Value.able Graduates: What are your insights on Australia’s embattled retailers?

Value.able TV #4 was recorded at Montgomery HQ on 15 August 2011.

Posted by Roger Montgomery’s A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 15 August 2011.

INVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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46 Comments

  1. Vish
    :

    Hi Roger,

    Apologies if this has been discussed already but I heard you last Thursday on Sky Business channel when you were asked to name a few stocks you bought recently for your fund and JBH was one of them. Although, I had written off JBH temporarily (more focussed on the likes of MCE,DCG and FGE !) but I thought I will re-visit (as JBH is trading at a decent discount to its IV) and check how the current valuation and debt to equity ratio is looking.

    Based on the data I have used from commsec- for 2011 the shareholder’s equity is 152 million and total long term debt is $232 million – returning a debt to equity ratio of more than 150% !! I must be doing something wrong here ? Must be something to do with a share buy back (worth $170 million) back in March..but still if I was to take out 170m from the current 232m debt – I get a debt to equity ratio of 41% for 2011 which compares to 12% for 2010.

    I then went back to ‘Chapter 8 – Debt is Not Always Good’ to reassure myself that we are looking to buy businesses earning good returns on equity while employing little or no debt (ok fine – it wasn’t me but Mr Buffet who said that :-))

    • Roger Montgomery
      :

      Hey Vish,

      Check out the cash flow and the interest cover please. You should be able to work out how quickly they can pay off the debt even while maintaining dividends.

      • Vish
        :

        Thanks Roger.

        Is the interest cover information easily available ? A quick google search showed that it can be calculated by diving EBIT/Interest expense. I could find the EBIT from JBH’s latest results but had no luck in finding the interest expense, may be I am not looking hard enough !

    • Andrew
      :

      Roger beat me to it, i initially baulked at the gearing levels but after checking the interest cover i can see that they still have quite a good hold of it and there for it is not necessarily a problem.

    • keith
      :

      I notice UBS has borrowed JBH shares … presumable to shortsell … happy days! Look for cheaper prices.

  3. Nap
    :

    Hi Roger,

    If JBH ROE is 88 then using the max ROE on tables 11.1 and 11.2 is not complete and would produce a lower value. Let us say you have a complete value for 11.1(pg 183) and 11.2 (pg 184) then potentially JBH valuation can go beyond $30. Am I correct to assume that?

    thanks

  4. Brad
    :

    Hi Craig B

    I read the Bart Cummings autobiography a few years back.

    My take on his success: he just loves race horses – and seeing his win……

    • Craig B
      :

      Seems he was a value player too, judging by the trips to New Zealand – apparently before it was fashionable – with a view to purchasing quality stayers on the cheap.

      I wish he was more expansive in that book though. I thought it was a little pedestrian.

  5. Michael Horn
    :

    I wonder if, in relation to retail sales, if anybody could comment on the “satiation effect”. I am constantly amazed at how much stuff most people own – two refrigerators, two cars, one multiple TVS and personal computing devices, new cell phones and a surfeit of clothes and shoes, and some of the folk in this category are government funded pensioners. Most Australians could withdraw from buying non-perishables for years, so a healthy pullback in purchasing things in favour of reducing debt and investing the spare cash seems sensible, good for the economy even.

    It would be a good thing if the retail industry trimmed down, and its human and other resources redeployed to where the need is. That self-promoted investment gurus advocate fiscal and financial policies to help the retail industry is putting the cart before the horse, in my opinion. The retail industry should exist to serve the needs of the public, rather than that the public should be manipulated to help the retailers.

    I am not anti-retail, and I hold shares in WOW and TGA, but I expect them to prosper on their merits without “nanny” intervening.

    I am thinking of some dy could comment

      • Michael Horn
        :

        I first thought of calling it “the economy of enough” but a squizz at the internet informed me that a Diane Coyle has written a values-laden book using that title. I wanted to avoid using words that had the same socio-economic message (for our descendants sake, stop pillaging the world). My message is not so moralistic, I merely wanted to say that:

        * never before in economic history has Mr Everyman had so much stuff;
        * the law of declining utility still holds;
        * declining propensity to consume is not exclusively occasioned by declining consumer confidence, so perhaps trying to boost consumer confidence is misplaced – boosting investor confidence is probably a good thing.

        The Latin word for “enough” is “satis”, so I sought terminology based on that – hence satiation effect”.

  6. Andrew Leon
    :

    Hi Roger,
    I’ve enjoyed your blog and read Valu-able early on.
    They’ve been a great help to my understanding for our SMSF investing whilst I’m still working full time. Thanks for your time & effort. I haven’t commented before as I didn’t feel I had much to add. The Value-Able TV is a nice addition. Congratulations and I’m looking forward to A1.
    Andrew L

    • Roger Montgomery
      :

      Great to welcome you to the community Andrew. Everyone is here to support each other and learn and there are many excellent and insightful contributions made so I believe you will be well served.

      As a friendly reminder to everyone here: We don’t engage in any personal judgement – we leave that to those that lurk behind ‘presumed’ anonymity in the dark crevasses of “forums” and engage in defamation, or encourage and solicit others to do the same. They know not what they reap. Its a reason we have resisted all requests to turn the blog into a forum. The demise of every popular forum thread is predictably the same – harsh words, sour grapes and name calling.

      You can relax in the knowledge that you are free and uncensored to make any comment or enquiry about any stock that you like. And you can also rest in the knowledge that nobody is free and uncensored to make comments about another individual.

  7. Rainsford
    :

    Just wondering if Roger or any grads have any comments on the US listed 3M Company ? By my calcs it is trading at a nice discount to IV, my inputs as follows, based on 2Q results.
    ROE 29% EQPS $21.96, Payout ratio 40% (conservative),. Gives IV at 10% RR of $105 versus current price $83.
    This company has consistently maintained ROE, increased earnings and paid a dividend for many years, thus I think the 10% RR is justified.
    Debt equity is 34%
    A truly global company, good moat and high spend on R&D.
    Would appreciate others comments.
    Keith

  8. Rainsford
    :

    Hi Roger
    Just back from a few weeks overseas and it was great to be able to keep in touch via the blog. and what a great post from Scott B!
    The retail scene is very interesting at present and I have read your comments on ORL, Zara, JBH etc. Re Zara the Spanish retail chain, they are everywhere in Europe and so is another Spanish retail chain called Massimo Dutti. They have a store in Australia now I understand and seem to be going gangbusters. The stores were packed, the service great and the offer (male and female) impressive. More competition for the poor Aussie retailers!

  9. Andrew
    :

    Observation can be such a wonderful thing. I have got around to putting the rubber gloves on and taking a good look at the results for JBH and found that the results back up some of my observations. I must be learning something. it’s one of the reasons i like retail companys, you can get a sense of the upcoming performance by going shopping.

    My observations which i have written about on here before were that less people seem to be buying stuff in stores (all old exisisting stores) and where they are they appear to be spending it on computers, phones and tablets etc and not DVD, games and CD’s.

    This appears to be backed up by the negative comparable store sales growth, negative sales growth in software but decent increase in sales in the consumer electronics section. Luckily the consumer electronics section makes up about 75% of sales.

    I think i would be correct in saying that at the moment growth is being achieved by rolling out new stores. Comparable store sales have also been negative during the July period as well but positive overall which leads me to believe that this trend is continuing.

    The debt is less of a concern for me now that i have had a deep look. Their interest cover, current ratio and other indicators of health are all still reasonably good.

    After looking into the inventory i can see that there are no major changes, just a slight increase on a per store basis as you previously mentioned.

    They have also according to their presentation, managed to extract some supportive terms from suppliers due to scale and have re-invested that into lower proces for customers which should help entrench its competitive advantage. Although the suppliers also appear to be chasing up their money quicker as well or JBH have decided to be a bit more generous.

    I have downgraded this company on my watch list from a level 1 to level 2 on the back of the declining comparable store sales trend and growth being achieved through roll out, roll outs can only go on for so long and at 13-15 stores a year they will get their sooner rather than later.

    The increased debt also played a case but not too much or else i would have put it off my watch list all together.

    JBH will need to start thinking about what they will do after roll outs and Roger has summed it up pretty well. I think (hjope) it will be mainly in the form of increased dividends and buybacks but i know that some people will find that boring and think an aquisition will be much more fun.

    There are some positive signs for the future, the newest versions of various consoles (nintendo Wii for instance) coming out might see the software sales get back into the black as well as the newest versions of smart phones (iphone 5 especially), tablets and computers should see the consumer electronics area continue to grow strongly but this is all specualtion. These products are becoming more and more a major part of everyday life.

    I am still neutral on the music streaming service and would like to hear more about it and how the cost structure is going to work out and what specific services it will offer. I only have a general idea at the moment.

    They still have that competitive advantage and as long as they keep that which fortifys the brand than i will be a fan as it is one of the strongest in the aussie retail world in my opinion.

  10. jeff
    :

    I went into one of the “new” JBH stores the other Sunday morning, typically a quiet time.
    This store has been opened a short time and is in a small centre (no supermarkets at all). I would suggest one of the “B” locations RM has mentioned.
    My impressions were:
    It was busier than I thought it would be given the time of day. The very helpful sales guy said it was quiet and doesn’t really pick up until after lunch on a Sunday “particularly when the (other major electrical retailer) staff come in”………Interesting?
    The staff were knowledgable , helpful and were easy to find. (Compare that with major department stores)
    For this baby boomer, I feel 20 years younger when I walk into any JBH store and have heard other old F#$ts say the same thing. JBH management and staff “just get it”! They provide a good experience to what is usually a chore.
    I have been buying stuff from them for a while now and I am at the stage where I don’t even look at another store to compare prices. I am confident that I will not be ripped off by shopping there.
    I think that all the above are part of the JBH competitive advantage and I hope they keep going the way they are. I also hope they do not alienate anyone with the proposed music streaming but feel fairly confident management will have taken the potential for this to happen into account.

    Jeff

    • Andrew
      :

      And that great service, especially for those that aren’t necessary big on the technical knowledge of the products, is something the online retailing world cannot duplicate.

      The service is likely to be a big element of their competitive advantage in the future as it will differentiate them from online retailing. Plus as Roger says the everyday low prices strategy which it does very well and monitors everyday according to their presentation to ensure that they keep it.

    • sapporosteve
      :

      Scott,

      I dont propose to be anything like an expert but I have been trying to get the “internet thing”. Apparently one of the successes for some companies is the ability to destroy or cannibilise parts of their own business and especially those parts that appear to be a success. I dont know enough about JBH to comment but just thought that this may well be their strategy (or part thereof). I would suppose that they are smart enough to see the streaming is a reality and will be possibly be the only way to purchase music and film in the future so they are adapting to meet the future. We may look back in 2 or 3 years and congratulate them on a brilliant move.

      Steve

      • Andrew
        :

        I am not sure i would call their online music offering cannabilising but i see your point. I would instead refer to it as changing when the industry environment changes.

        Just as CD players are dying and being replaced by MP3 players (even most new cars have mp3 players standard now) than so goes the tangible CD to be replaced by a data file downloaded online.

        I am not sure if it is going to work for JB but i think it is something that they have to do if they want to see growth in their music sales and could lead to further inmprovements if/when DVD’s and games make a similar change.

  12. Ash Little
    :

    Exceptional stuff Roger,

    As a lot of you know I have been visiting this blog since close to inception and what I think about it can’t be expressed in words but value.able TV takes it to another level.

    Thanks Roger

  13. Scott T
    :

    Every episode just keeps getting better.

    Many thanks for putting in so much time, to educate and enlighten so many people.

    By the way, great numbers from CCP today

    All the best

    Scott T

  14. Matthew Smith
    :

    Roger,

    In 2010 ARB Corp paid a special dividend of $0.40 which was fully funded via a bonus shares plan & DRP which was completely underwritten and therefore cash neutral to the business.

    Are you aware of the reason for this special dividend and the way it was structured??

    Robert Fraser organised the underwriting through his TaylorCollinson which he is also a director – they received fees of $465k

      • Prasad
        :

        Roger what POR did you use for ARP? Since it has habit of paying special dividend, did you use average of last 10 years (90%) or next financial years anticipated POR of 50%? You must have used 50% otherwise it is trading at a premium? – Can you please explain why?

      • Roger Montgomery
        :

        Hey Prasad,

        Obviously you can average but there are other options. Typically investors who try to get my exact valuation are focusing on the wrong thing – they also become upset that I don’t offer all my IP ( and for free here). You will get your answer here though because there is a large number of value.able graduates that can help.

      • Craig B
        :

        Racehorse trainer Anthony Cummings often says of his father Bart:
        “He taught me everything I know. Unfortunately, he didn’t teach me everything he knows.”

  15. Darren78
    :

    Hi Roger, my IV for JBH is different to yours.

    I have $21.48 and $27.60 for 2012 and 2013 respectively using RR of 12%.

    Can someone tell me where I’ve gone wrong?

    Num Shares: 98,000,000
    Beg. Equity: $152,300,000
    2012 NPAT: $135,200,000
    End Equity: $206,380,000
    Equity/Share: $2.11
    ROE: 0.88
    POR: 0.6
    V1: 5
    V2: 18 (highest multipliers from pg184 table)

    I bought in at $16.90 thinking I had a good MOS but after seeing Roger’s estimate, it doesn’t look so good anymore!

    Thanks.

    • Darren78
      :

      Oh, forgot to say, good video about JBH! Thanks. Even though my MOS might not be so good, it still sounds like JBH is a good bet for the future. As long as they pay down that debt pretty quickly.

      • Nic Arena
        :

        Hi Darren,

        I used an end equity of 153m – so my eqps was $1.56.
        You don’t say what RR you used but I used 12% because of the increase in debt and that the model JBH is using will need to be adapted over the next few years. Everything else looks good (maybe increase payout slightly I used 65%) and my IV is $16.87 (2012) and $19.67 (2013). Don’t know where you got your end equity but that seems to be the difference between mine and yours. Maybe Roger uses another value? Hope that helps.

      • Darren78
        :

        Hi Nic,

        I used RR of 12% too (although only at 60% ROE because the charts don’t go any higher).

        I calculate ROE on ending equity…I think that is right?

        To calculate ending equity I must use the forecast 2012 NPAT of $135.2m and then remove the expected dividend payout ($135.2 * 0.6) and add the result to the beginning equity.

        My EQPS value was from beginning equity of $152.3m (from their 2011 annual report) divided by 98m shares on issue.

        Thanks for your insights Nic.

    • Andrew
      :

      Hi Darren,

      I wouldn’t try to match Roger’s IV. That is not the point of what we do. You need to come up with a valuation that you are happy with based on your situation.

      We do not know the exact inputs Roger uses to come up with his valuations. This would be more than just a difference in RR as well. Like Roger has said earlier, the formula he presented to us in value.able is a leg up and not a hand out. It has some limitations as he mentions in value.able which Roger would overcome based on his experience, thats why people are happy to give him their hard earned to invest on their behalf.

      For your help my IV for 2011 is $16.89 on a 11% RR. I have al ower profit and ROE figure and lower EQPS. I am not saying i am right but that is what i get and what i am happy with. If i use the statutory and normalised profit my IV is closer to $10-$11 for 2011.

      • Andrew
        :

        Sorry Darren, saw you were referring to the 2012 year. it is even less likely you will get close to Rogers forecast valuations as you woul dneed to use and interpret the exact same research he gets.

        My 2012 valuation is $22.32 but if i change to your 12%RR i get $19.71. I have a NPAT of about $125,000, ROE of about 77.7% and i am using a reasonably high POR of around 80%

      • Darren78
        :

        Hi Andrew, well $19.71 is pretty close to my estimate for 2012.

        I was not aware that the value.able formulas were just a “leg up” and not the actual formula that Roger uses. I do understand though that he does not release the formulas for calculating MQR.

        This is kind of disturbing because if Roger gets $20 for 2013 and I get $27.6 (which I do) then that is a difference of 35%. That much of a difference can easily be the choice between an average investment or a great investment.

        I want to make great investments!

        I know people will get different IVs based on different forecasts and required returns, but I thought everyone should get roughly the sames values, that is, in the same ballpark at least.

        At least I am having an educated stab in the dark now compared to a year ago :)

        Thanks for your help.

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