Will JB Hi-Fi continue to groove?

Insightful Insights | Comments (95)

Will JB Hi-Fi continue to groove?

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.

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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95 Comments

  1. Joab Soh
    :

    Some “market research”…

    iPad 2 is out today in Australia, and JBH is selling them a couple of dollars cheaper then the actual Apple Store. So I know where I am going to get my iPad 2.

    Another “big thing” is Nintendo 3DS. The latest handheld is in store in March.

    I believe these new product launches will benefit JBH in the short run.

    I also recall that there was alot of positive impact then when games consoles such as PS3 came out 3 years ago.

  2. Nic Arena
    :

    Interesting article about JBH below:

    http://www.current.com.au/2011/03/10/article/JB-Hi-Fi-has-the-best-multichannel-offering-expert-analyst-says/CLULXIDQQY.html

    I for one think JBH is being written off way too fast. I agree that the IV will slow but this is obvious as it was never going to continue the way it began (nothing ever does) but it still has good value left going forward. I’m happy for the price to be continued to be hammered, as it will present a buying opportunity for me in the future.

    • Roger Montgomery
      :

      Don’t disagree with your summary Nic. Regarding the article; watch the numbers in the full year result and always check what interest the broker may have in writing the piece.

  3. ben
    :

    Interesting story on VOC (i think it was on alan kohler’s site?). NBN will have a impact on VOC- I’ve been doing a little work into it and I think the stock is viable for a short term trade (i think you implied that in your story). My understanding is that they buy/sell bandwith .. technically speaking there is possibility the NBN can buy/sell bandwith and essentially become a competitor to vocus the way that telstra does wholesale DSL whilst offering DSL services in the space. It also presents an opportunity for Vocus to also purchase fibre off NBN. The public and candid response from voc’s management to the NBN indicates to me that they see NBN as a imminent danger and the way they disclose the effect of the NBN in their prospectus (or lack of disclosure.. ‘i dont know’ excuse is rather opaque) really accentuates the point. I havent looked at the revenue composition to know how badly itll impact.

    Also, a trading halt has been request- I’ve spoken to some people and they seem to reckon a capital raising is imminent and a telco analyst i’ve spoken to reckons they’re after an acquisition… and I know how you guys feel about that.

    The business on the Southern Cross Cable would be uneffected

    My 2cents.

  4. Craig
    :

    Hi Roger,

    Some time ago you posted about forecasting instrinsic value. I found this extremely beneficial.

    Along those lines, I was wondering if you may consider a post with some hints and tips about updating current instrinsic value when half year results or other financial announcements are released.

    I guess I am looking for some reassurance that I’m coming up with the right inputs. Are the any traps to watch out for, etc.

    Thanks Roger.

    Regards,
    Craig.

  5. Duncan
    :

    Hi Folks

    Can anyone substantiate whether Woolworths have any business interest with Metcash? This is something i didn’t realise. i was under the impression they were two completly different companies.

    Shelving is known as realestate within woolworths and they make more money out of selling the shelf space than selling the products. Eye level is the most expensive area to rent and the price reduces as you move up or down from that area.

    Fewer brands are willing to pay the high eye level rents any more giving woollies the opportunity to add their homebrand items in these prime positions. Probably a Woollies ploy to increase profits further. I will take note next time i’m in the supermarket. i won’t be rushing there mind you!! That’s the wife’s job.

    They are also in the process of buying up chemists supposedly because they weren’t allowed to open one within their stores?

    Just interesting to me so thought i’d pass it on.

    Dunc

  6. David King
    :

    To David Sinclair who asks me which of WOW or ORL would I like to own if I were to be forced to hibernate for 20 years: my answer is of course, neither. I think he is hinting that perhaps food and hardware are safer than sparkly handbags, but really, it ain’t necessarily so, and the truth is that no investment left unchecked is safe. This 21st century world’s economy is just too fragile not to be constantly clocked and adjusted for. I’m no more a prophet than Roger, but for what it is worth I don’t think this is the time to be as serious about owning Australian retail stocks as the volume of letters here suggests. For an overview of just how small our market is, and how many retailers service it, you need to hit the road, get out of your city and travel by road right around the continent of Australia. Then tell me if you still like MYR, DJS, WOW, JBH, HVN, Metcash, or WES at present prices. Check their IV’s. Not one of them is worthy of your consideration. Look elsewhere and maybe, Roger, you can suggest a company or two….

    • David Sinclair
      :

      Hi David,

      No, I wasn’t “hinting that perhaps food and hardware are safer than sparkly handbags”. I was asking you which business had the more durable competitive advantage.

      It is a question worth considering.

      David S.

    • Steve I
      :

      Given this sort of sentiment about the size of our market which impacts on the pace of growth at larger sizes, in addition to the lack of success (in general) in overseas expansion of Australian businesses, I’ve been thinking about looking at overseas opportunities.

  7. Brad
    :

    I’m with you Rici

    JBH is a great business but competion from the internet and a probable decline in CD and DVD’s as a format could commoditise this business going forward.

    Should do better than cash but not a get rich stock going fwd, IMHO.

  8. Rici Rici
    :

    I’m sorry but i’m not interested in JBH at all at these prices.
    I have a contact in their burke st shop in melbourne. I check in from time to time both with the person and to view the ‘check out line’.

    Commenatary from the person (as of two weeks ago):
    ‘its been a surprisingly quiet couple of weeks, relative to normal’.

    The ‘check out lines’:
    personal observation: much thinner than usual. One of the traditional headaches with JBH was queing to pay for the goods. Well this isnt a problem anymore.

    JBH may be ‘best of breed’ compared to the rest of the traditional retailers. But i dont buy something just because its best of breed. I want best of breed at an attractive price (or second quality breed at a damm good price and preferably after the country as a whole as come out of a recession).

    Sorry guys but i am not biting at these levels.

  9. Ash Little
    :

    Hi Room,

    I just went back to grad school for a refresher by rereading the buffet letter to shareholders.

    This one from the 2007 letter which in my view is very relevant for JBH

    “Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so: Truly great businesses, earning huge returns on tangible assets, can’t for any extended period reinvest a large portion of their earnings internally at high rates of return.”

    Buffet was leading into See’s Candy and JBH is no See’s Candy but I think this is appropriate

    • Roger Montgomery
      :

      Nothing wrong with a high ROE and a high payout ratio – a bit like an A-rated bond really. First prize of course is the company that can retain high amounts of profit and re-employ at high rates of return.

      • David Sinclair
        :

        Read it and had a good laugh. Ruslan Kogan has a history of making bets like that and losing them. His website currently has a link to the new Myer online site because he lost a bet that the site wouldn’t be opened within three months of Myer’s announcement. It is probably just his way of getting free publicity, which he needs in bucketloads because his products are not very high quality.

        From Apple’s point of view I think that pulling their products from stores and selling exclusively on their own website would be a mistake. If the average consumer goes to a store (physical or online) to look for a phone/tablet/latest gadget and is shown the current range of Android gadgets and nothing else then the most likely outcome is that they will purchase an Android gadget. If Apple sell exclusively on their own website they either limit their market to their fan-boys or they need to put a lot more effort into marketing so that people will go to their website before they look anywhere else. It would be much easier for them to maintain a presence in other stores.

        David S.

      • Joab Soh
        :

        All,

        Update on this discussion.

        Below is an article from bloomberg about estimated sale of iPad 2. Quote below around increase in distribution of stores where iPad2 is being launched in US. Clearly, Apple understands the power of first mover advantage to saturate the market with a new superior product at a reasonable price. This further proves that JBH will benefit from this on 25 March (estimated launch date in Australia).

        “The iPad 2 will be available at 236 Apple stores, which will close from 3 p.m. to 5 p.m. to prepare for the release, Amy Bessette, a company spokeswoman said yesterday.

        Apple’s new tablet also will be sold at more than 10,000 stores of AT&T Inc., Verizon Wireless, Wal-Mart Stores Inc., Best Buy Co. and Target Corp., according to Piper Jaffray’s Gene Munster.”

        http://www.bloomberg.com/news/2011-03-11/apple-poised-to-sell-600-000-ipad-2s-in-its-debut-outpacing-first-model.html

        PS: I personally will be getting an iPad 2 from JBH when it is out in Australia.

    • Bruce D
      :

      I wonder if it would be appropriate for a CEO to take on a bet, particularly a very large bet on the future strategy of the company ? If for some reason (cant think quite what) in two years time there were business reasons to stop selling Apple products, could that decision be influenced or seen to be influenced by a personal bet running in the background ?

    • Pat Fitzgerald
      :

      Hi Bruce C

      Do you work for Kogan (or are you Kogan) ? Good publicity stunt. What competitive advantages and barriers to entry does the Kogan’s business have ? I think he needs to improve the quality of his products and lower the prices.

      • Bruce C.
        :

        Never heard of Kogan before I read the article, I posted it up for the interest of bloggers. Don’t like it don’t read it.

        As for the rest of your questions, don’t really care.

        Cheers.

  11. Stephanovic
    :

    How do you get a good grasp of the companies pricing power? Is it simply margins?

  12. Martin Anderson
    :

    One factor which I don’t believe has been mentioned is that a significant proportion of existing stores are yet to mature. If you read JBH’s results presentations, they discuss the fact that profit growth lags revenue growth in each new store. So even if they did not open any more stores, profitability would be positively impacted by this factor for some time to come.

  13. Rici Rici
    :

    The only retail positions i I have are reasonable sized positions in Thorn Group (TGA) and Cash Converters (CCV) as well as in the financing group (FXL).

    All of these positions have shown decent growth in their share prices, so i would not be a strong advocate at buying at current prices.

    The only retailer i am CURRENTLY viewing with a view to increasing exposure is Kathmandu (KMD). I only have a small exposure currently. The difficulty here is trying to get a picture of their profit potential given that they just recently listed. If one can believe the broker forecasts, then based on those forecasts KMD is trading on a significant discount to IV.

    My position and the addition of further funds to KMD is dependent on further positive management commentary, and preferably the price contracting further from its recent run up.

    Here is an interesting trading potential with KMD. KMD is a NZ stock, so watch the AU$/NZ$ movements. It can present opportunities.

    • Simon Anthony
      :

      Hit by recession and weakened consumer sentiment after listing in November 2009, Wednesday’s rally takes Kathmandu shares back near their initial listing price of $1.70.

      The company will report its completed first half results on March 17. We will then be better placed to calculate intrinsic values for 2011/2012

      • Rici Rici
        :

        Politely, who cares what their IPO price was, it has no relevance on future intrinsic value.

        The key for me with this stock is management commenatary. As i said based on broker forecasts, the stock is trading under IV.

        Therefore the key for me is updated positive management comentary. The key being declining sales, and of course any mention of declining profits.

        So long as profits are going up, sales going up, and IV below current price i am happy with my initial position. However the key is when to add to that position.

      • Simon Anthony
        :

        Kathmandu intends to drive sales growth through:
        1.continuing the store rollout in Australia and New Zealand;
        2.optimising its existing store footprint;
        3.introducing new products; and
        4.continuing to develop its online capabilities through its new
        transactional website.

        In addition to these sales growth strategies, Kathmandu has opportunities to enhance profitability through controlling cost as the business grows, through further investing in systems and technology to deliver efficiencies and savings, including potentially through a reduction in supply chain costs and lead times and improved inventory management.

        Kathmandu has identified a potential 150 store network across Australia and New Zealand. Fifteen new stores were opened in FY2010, and a similar number is expected to be opened each year for the next three years. As at 31 October 2010 total store numbers were:
        # 55 in Australia
        # 36 in New Zealand
        # 6 in United Kingdom

        Sound familiar (TRS, JBH etc)

        While KMD results have varied from store to store, most stores achieved profitability in a relatively short timeframe from opening. Stores that were open 12 months ago have recorded stronger sales for the same period over Christmas 2010.

      • Rici Rici
        :

        thanks Simon.
        But the key to KMD is the current years profit relative to the share price.

        KMD is a MUCH lower quality business compared to JBH (however i dont like JBH at current prices).

        However the market is potentially marking down KMD’s share price based on scepticism.

        If the starting price paid for KMD’s business is much lower (as reflected in the share price), then one doesnt need the same level of future profit growth from future store roll outs to justify an investment at current prices.

        By the way as mentioned i have only a small investment position in KMD because i dont have a high level of conviction in what i am saying.

      • Roger Montgomery
        :

        Hi Rici Rici,

        Kathmandu as an A3 but trading at a large premium to intrinsic value of 94 cents. I have IV rising to $1.23 in two years time. Hope that gives you something to compare your work to and remember seek and take personal professional advice.

      • Rici Rici
        :

        Hi thanks Roger. Wow we have a huge difference in IV estimate. Could it be primarily due to different profit forecasts?

        I am using consensus forecasts from morningstar. They have estimated profit at $38.4 million.

        Based on this:
        Shareholders equity: $192 million, payout ratio of 55%, 2011 Equity of $192 +(45%x$38) = $209 million 2011 equity

        ROE= $38.4million/$192 million = 20%

        Basic IV: [$209million x (20%/10%)]/ 200 million shares on issue = $2.09

        Conviction level: low because of lack of historical consistent profit trend and the use of forecast earnings.

        Any help on this from people on this blog would be greatly appreciated.

      • Rici Rici
        :

        actually i think i may have a big flaw in the above, i need to do some more research but the above profit figure could be NZ$, yet the analysis is done using AU$

  14. Steve I
    :

    Whilst I think that JB is a fantastic business (I don’t own it), it does have some headwinds. The area that I’m most concerned about is my view that we are heading into a rising interest rate (and oil prices!) environment. This means that there is less money to be spent on all non-vital retail products and I don’t think that JB can avoid the impact.

    Therefore it is my contention that they will not be able to continue to grow their IV as they have in the past based on the current business model.

      • Steve I
        :

        Roger,

        Point taken about the savings rate, I was surprised to see the increase. However I don’t think that we have yet seen the impact of oil prices and cost push inflation. I reason that we will start to see the impacts through this year.

        Further, given the continued elevation of our private debt levels in this country, an oil price and/or interest rate shock would have consequences which would immediately wipe out any short-term pick up in savings rates which are probably too little too late.

        Sorry for my negative views, but I cant find an alternative conclusion.

        Having read the work of Jim Rogers and cycles, I’d say that companies like JB will fit perfectly in my portfolio mid-decade onwards and hopefully prices will be attractive due to the nature of the economic scenario that seems (at least to me) somewhat inevitable.

        In response to Rob, I don’t think that a third flat screen TV, upgrading to 3D TV or purchasing the sexy new gadget will be a priority in such an environment and therefore does not have the same substitution potential as with Mc Donalds. Clearly life will go on but I do think that continued growth during this phase will be incredibly difficult.

      • Ash Little
        :

        Hi Steve,

        I agree with a lot of what you have said but remember that when things get very tough it is the survival of the fittest and the fittest take market share from the others.

        Great businesses not only survive but thrive in this environment.

        I would love a very very tough environment for this sector in the next few years.

        My dream is for maybe half of the existing HVN stores being rebranded as JBH and the rest ceasing to exist in 10 years time.

        Now that would be nice. (Unless you own HVN)

        Just my thoughts

      • Ben
        :

        The retail space is always going to be knocked and battered around. No matter how much they talk about rising interest rates, oil price shocks, business confidence, currency, the internet and ‘higher savings’.. you have to really look past all those things because they are transient. (I dont think the internet is transient.. but i do think ‘higher savings’ is)

        There is hardly ever any ‘paradigm shifts’ .. At the moment yes, some the retailers seem expensive.. but keep an eye on the space and watch as more negativity spews out and watch the share prices tumble.

      • Steve I
        :

        Ash,

        I do think JB will survive and agree that they are the fittest. This means that it will be on my list when the time is right for me.

        Should I sign you up for the HVN fan-club lol?

      • Ben
        :

        Itll be interesting of JBH would actually attempt to consume HVN considering that HVN actually owns alot of the stores it has.. so it gets a rental stream from the franchisees.

    • Rob
      :

      There is also the other side of that.

      Just as, during hard times, cheaper end restaurants (term used loosely here) like McDonalds do well, so too is JB positioned to benefit from customers looking for cheaper options.

      Upmarket businesses are the ones that will suffer most.

      Cheers
      Rob

      • Andrew
        :

        I agree, the tougher the economic climate the more likely people are to be price concious. JB Hi Fi is the cheapest so would be far less impacted by the economy than other retailers.

        People who understand fashion also know that in these times the higher end luxury brands tend to do pretty well as people will be more likely to buy that one expensive dress that will make them feel good rather than a bunch of smaller ok but nothing spectacular dresses.

  15. Joab Soh
    :

    All,

    I tend to agree with some of the earlier comments that a matured company with significant competitive advantage is not a bad thing. Even though IV decreases as payout ratio increases, it’s still an A1 business, and it will still earn more compared to a bank account. Again, it does depend on what the board is going to do regarding capital management.

    Also, considering portfolio construction, no matter how good other companies like MCE is, I would not want to put 100% of my investment money in is just one stock. Accordingly, there’s room for a JBH in a portfolio 6-8 stocks.

    Regarding online retailing, I think it’s just more a flavour of the month. I personally shop online and what’s the trade off… you are saving money, but forgoing the satisfaction & convenience of taking it home immediately. Take my 3 years old, she wants to play with her new toy NOW. So, if I am buying something that matters (my own toy), I rather pay abit more and get my hand on it now then to wait patiently everyday for the mail man.

    So the key is how much will you be willing to pay for convenience… I believe that as long as the pricing is not significantly different. Brick and mortar still have an advantage. Hence, JBH’s cost competitive strategy ensures that it remains competitive, even against online stores.

    Lastly, another strength I see in JBH is the constant evaluation of product mix and shelf space. I visit JBH stores very often and I do notice how quickly items change accordingly to demand. Comparing to 12-18 months ago, there’s now a dedicated area for Apple products, and laptops are on more shelfs (with desktops gradually disappearing). And there’s more area on portable hard disks, router and stuff (for all you internet fans). To me, these are clear signs that they understand the constant change in consumer demand.

    So, JBH is not just a cd/dvd stores, even if you download stuff on the internet, you still need to buy a hard disk from JBH to store them.. = )

    • Peter Kruckow
      :

      Hi Joab
      Just another thought to add to the online retailing debate, if the item is too big for the postie to carry , they give you a card notifying you to go to the P.O. , which these days is quite often located at the local shopping centre, which negates the advantage of buying online , so there are limitations regarding the size of a purchase if you have to travel to pick it up.

      Cheers
      Pete

    • Peter M (Mully)
      :

      Another aspect to consider in relation to online versus bricks and mortar retailing are the payment terms. In the case of the former, payment is usually by way of a lump sum via paypal, credit card, EFT etc. If a credit card is used for periodic payment, it is usually accompanied by a relatively high interest rate. In the case of the latter, you not only get your hands on the product immediately, but can arrange to finance it over a reasonable period of time on reasonable repayment terms such as those offered by TSM to the likes of JBH and Dick Smith customers. In respect to this customer segment/demographic, it provides these retailers with a distinct competitive advantage.

      Mully

  16. John A
    :

    Hi Roger and Everyone,

    I think a big threat is a technology like ‘Red Laser’ that is an iPhone app that turns your phone into a bar code scanner so you can check and compare prices. Having this app means you can, for example, go to your local electrical shop and be fully informed on where the nearest-cheapest item is that you are shopping for. Alan Kohler mentioned this some time ago. How many times have you bought something only to find the exact same thing at another shop only cheaper! Happens to me all the time. Something like Red Laser is a great bargaining tool for shoppers when you can say to the shop keeper ‘x’ shop down the road is selling this cheaper. If this type of technology takes off then margins for retailers have to be squeezed.
    I think what retailers have to focus on is the advice and service they can give to customers that you can’t get on the internet. I think there is an opportunity for JB-Hi Fi to move up the ‘food chain’ of technology a bit and provide more detailed advice on what is sure to be more complex ‘gizmos’ to be released in future. I’ve found JB staff very helpful so maybe JB Hi Fi can make ‘service’ a point of difference and a greater competitive advantage?

    Cheers

    John A.

    • Paul Middleton
      :

      John

      I feel you’re on the money with your ‘service’ angle. Evidence suggests JBH have this competitive advantage, employing young tech savvy people with good communication skills (generally speaking). I see Dick Smith currently trying to replicate this approach. And as you indicate, advice is ever more needed in this age of exponential take up growth in technology.

      I liken JBH to another retailer – FLT, now mature in the Australian market. While FLT looked overseas for the next leg of growth, it was poor timing and/or poor judgement that led to the acquisition of Liberty in the U.S bringing losses and write-downs (a common method to erode shareholder wealth employed by Australian company directors).

      Yet JBH and FLT have a future, irrespective of competition from internet retailers. Consumers always value service. I know when I buy tickets to fly overseas, I prefer to book with FLT because they have the knowledge and advice that I require.

  17. dan
    :

    perhaps JBH will push into asia as ORL is doing, particularly china and india! if management is competent, i believe this to be a possibility…

    • Andrew
      :

      I think NZ would be the most likely. Canada has potential but can you see JBH being competitive against the likes of Walmart etc. There are some big companies here and as good of a business JBH is, it will take significant investment to get any type of competitive position in the really big markets.

  20. Andrew
    :

    With all the talk about the effect online retailing will have on the future of retailing businesses, it is interesting to see what further effects this will have on other ares for example commercial property.

    Is there a future in shopping centres if the most bullish views on online retailing become a reality? What can we reasonably expect?

    Logically, if businesses turn more into the online retailing environment than there will be less demand for shopping centre retail space and go towards industrial warehouse type facilities. Short shopping centres and go long on industrial?? A look around my local area shows that my area is perhaps oversupplied with retail space with two shopping centres struggling to get tennants.

    I think there will always be a need for shopping centres as the task of shopping is more than a means to an end and can be a day out.

    Australian retail chiefs will need to be creative as to where to go from here as most retailers are boardering on saturation and our population is not growing out enough for new markets to develop.

    I would not be surprised to see stores become more showrooms where they display their products and you then order through the online portal. These display stores will have little to no inventory in the stores as they would be held in the distribution warehouse meaning less need for retail space and there for less money on leases. It will have the affect of keeping the brand visable in shopping areas and operating at the cost structure of an online business.

    • Adam W
      :

      Hello Andrew

      Stores like Argos in the UK have been doing something similar for years. Their products are usually cheaper than the High Street stores will large amounts of floor space. In the case of Argos you get their catalogue (which is about the size of a small phone book) and you can either order online or go to one of their stores. There stores are nothing more than a large warehouse with a cashier out the front.

      Cheers
      Adam W

  21. Jason Prowd
    :

    Interesting post Roger!

    Having read your book last year I think perhaps JBH is a useful example of the inherent weakness in the ‘Value-able’ model that you alert readers to on page 193.

    The model as I understand it extrapolates ROE into perpetuity (you call it a ‘straight line’ model), weighting the valuation according to the percentage of capital retained within the business, at the time of the valuation.

    The model has intuitive appeal as it’s amazingly simple to apply and gets to heart of what creates value in a business -namely the ability (or lack there of) to generate returns above an investors cost of capital.

    My concern is that very few businesses – even the best ones – have been able to return high ROE for lengthy periods – as you’ve identified with the JBH as they grow their ROE tends to reduce as profitable options for expansion are reduced.

    I’ve been wondering whether this is something you have thought about incorporating into the model?

    Cheers,

    Jason P.

    • Roger Montgomery
      :

      Hi Jason,

      I thought I was very open about the flaws in the model and even here on the blog I have spent a vast amount of energy bringing down valuations that are the result of a high ROE/ Low Payout combination. In my book I talk about the “implied Growth Rate’ and the importance of checking whether it is realistic. If not you must either lower the ROE or raise the payout. Thats a simple solution. You can get far more technical and I expect that would be your temptation. The problem then of course is falling into the trap of becoming precisely wrong rather than staying ‘about right’. Remember this is an ‘estimate’.

  22. slide
    :

    Let’s all bear in mind that the current reatil conditions are extremely difficult, and JBH continues to shine much more brightly than most in this environment.

    Yet, considering consumers are looking to spend less, they may be looking to rent the latest entertainment product (TGA) than to buy it. This is one company, A1 to boot, going places. Solid management, ROE going up, room to grow, and their inventory is getting cheaper and cheaper to buy as the US peso stumbles.

    • Ben
      :

      I actually like the TSM model better- they don’t hold any inventory (no inventory risk), they are a simple middleman who earn commissions (sound familiar?)

      • Ben
        :

        I must add, TSM’s SME audience I think will be more wary in taking up these rentals simply because of the leverage aspect thats being introduced with operating leases (operating leases will now be capitalised ie on the balance sheet)

      • Ash Little
        :

        Hi Ben,

        The new lease standards will have no effect on the economic performance of the business,

        What you say is very true about operating leases being capitalised on the balance sheet.

        But this is for the people who are in receipt of the “asset”
        .
        If you have a photocopier on an operating lease then if it is material you will have to bring this on to the balance sheet and show the liability.

        TSM are the reverse of this.

        They are the ones providing the lease

        For every loser there is a loser there is a winner

        I think TSM will be the winner on disclosure but the economic performance will not change

        Hope this helps

      • Ben
        :

        Thats precisely the point- with assets coming onto the balance sheet, businesses will turn to loans or other forms of financing to bypass the lease.. the whole point of the appeal of the operating lease was that it was off balance sheet and made the whole thing look tidier.

        In essence, its taken the bite off one of the segments of TSM’s market.

  23. Nick Mason
    :

    Hello Roger,

    thank you for your column.

    Had I read yourself and Peter Lynch earlier in life no doubt I could have made a lot of money investing in JB Hi-Fi. I remember very well many years ago visiting their store on Hay st (Perth) and being amazed by how many people there were constantly shopping inside. I also remember the last time I was in Perth visiting their new store in Claremont and being far less impressed.

    A friend of mine bought a phone cover from this store although was disappointed with it and subsequently purchased a far superior one over the internet for 1/5 of the cost (including shipping) later on.

    JB Hi-Fi may currently be an extraordinary business although I do not predict it to come close to emulating its success of the past. Readers of this forum may see the threat of internet retailing as a chance to buy into a superior business during times of fear although I see internet retailing as a massive growth industry and traditional retailers on the way out. If traditional retailers are to compete it would require them to massively slash current margins.

    Wonderful businesses with wonderful growth prospects at wonderful prices. In my view JB Hi-Fi currently only qualifies for the first category.

    • David Sinclair
      :

      Truly wonderful businesses with wonderful growth prospects are rarely, if ever, available at wonderful prices, which is why WB is prepared to pay a *fair* price for a wonderful business. I suspect that if we insist too much on wonderful prices we will tend to overestimate either the wonderfulness of the business or its growth prospects (or both).

      I would suggest that investing mostly in wonderful businesses at fair prices (and the occasinal fair business if the price is sufficiently wonderful) will lead to good enough results to satisfy most people. Having a bit of cash on the side for the rare occasion when you find a wonderful business at a wonderful price will then put the icing on the cake.

      David S.

  24. ken fraser
    :

    DAVID, Great summation of the retail companies mentioned. Simply explained and straight to the heart of the matter with all the major points covered with very few words.

  25. Ben
    :

    The brick and mortar retail space is a model that will always be limited by the geographical confines of this country as Roger mentioned. Thereby leading to the situation we have here- a business reaching maturity faster than their counter parts in North America. However with a mature business comes a what I’d like to think are steady cashflows; JBH will forever be the one stop shop for tvs, dvds, etc. There are some aspects of its revenue streams that it will need to look into and I think the CD business really needs to be re-examined..

    There are also talks by analysts of the possibility of looking towards the embattled REDGroup. I sincerely hope the management strike that as the business of book selling in Australia atleast isn’t conducive to sound business.

    I’ve said it here and and i’ll reiterate- internet retailing overcomes the problems we have here in Australia as the target audience is limitless and the setup costs significantly detract from the lease liabilities of the retailers (making the balance sheet tidier). The lower COGS means that the product being pushed out is cheaper and winning market share is the key when faced in a mature business. I always turn to ORL’s online shop—> out of the 80
    they have, it has GROWN towards the top 5 seller- thats telling sign to indicate its not a phase…

    • Andrew
      :

      I agree, CD’s are dead in my opinion. Singles have already dissapeared and with more and more people having iphones, ipods and other mp3 devices and cd players and car stereos having mp3 players as standard there is little need for CD’s. They will go the way of vinyl and cassettes.

      JBH could go into MP3 online downloads and go head to head with iTunes is a possibility and i think people would actually be receptive due to the view that iTunes is more expensive than it should be when compared to other countries in australia but the apple dominated market will make it difficult.

      I think Book Selling if they can get rid of the various protection issues that cause books to be so much more expensive than online or overseas dissapears could be a better area than CD’s but JBH don’t have the power to control the issue that will make it a good business.

      The problem with internet retailing is that you go from having little to no competitors to hundreds and thousands of them. Barriers to entry are low and there are some heavy hitters in this space. I think in this market JBH is the only company that could make it successful and there are advantages as you mention (lower costs etc) to entering this space and succeeding. It is one strategy i think they could do to start the next chapter (post capital review) that could be positive in the long term although could canablaizre existing earnings in the short term.

      • Ben
        :

        What you comment about the internet is true- it is really is a barrage of competitors and what not. However, you have to understand that JBH will come in with
        a) a STRONG brand-customers will know
        b) More importantly; they have the scale to do this.. yes there are thousands of competitors but all of them are start ups and don’t have the size to compete. I like to think JBH going into the internet space would be a colossus meeting mounds of ants.. It can loss lead on products and aggressively target the smaller competitors and virtually squeeze them out… this will be exacerbated by the ease of access to prices by consumers.. so its sorta like brick and mortar retailing on steroids- instead of driving across suburbs to find a decent price, you find a better price with one click.

      • Matthew R
        :

        I think the effect of the Internet on many retail businesses is over rated. The Internet is not the first medium through which people have been able to buy items without leaving their home….

        There are those items which are more efficiently purchased via the web (an obvious example is books ie Amazon), but there are plenty that are not (think Banana Blue vs WOW).

        I believe thoughtful consideration of how a business competes in it’s industry provides some insights in to the future. In this respect I think JBH has it’s challenges but it has a fair bit of time left before it will be really pressured by the Kogan’s etc of the Internet (if ever).

        On a side note, I think if Kogan ever wants to be a big competitor in the electronics area he needs to protect his brand a little more carefully and limit the outbursts!

      • Andrew
        :

        I agree with you that the effect of online retailing will differ depending on the type of products. The problem with JB Hi-Fi is that i think it falls into the amazon example more than the WOW one.

        Apple and Amazon has shown how easy it is to sell movies, songs and games online. I also believe that hard drives will replace the need for DVD’s and CD players. You also know what your getting with the electronics sold so there is no need to really have to see it before you purchase it either.

        Most of JB Hi-Fi’s products i think can be easily sold online.

        I think online grocery shopping will not however catch on as people will want to make sure of the quality of fruit, meat etc and want it straight away rather than wait for the delivery and take time off.

  26. Chris B
    :

    Hi Roger,

    Personally I have become progressively more bearish on the retail space over the past year. Now I would never try and guess where interest rates are headed in the short term, but if inflation creeps north (or leaps north???) as I suspect it will then so to will interest rates.

    we have the highest quality retialer (JBH) nearing maturity, we have WOW going head to head with WES by launching their own Bunnings equivalent, we have entered an environment where online shopping is surely going to impact retailers margins at some point in the future (possibly in a big way unless our retailers can adapt – fast), and this is all happening in an environment where inflation and interest rates are quite possibly going to continue going up.

    There are of course a few other high quality retailers out there (I like DJS, ORL, TGA, SUL) but I have all of them trading at premiums to estimated value except ORL.

    I’d be interested to hear what other people’s views are on the current environment for retailers?

    Chris B

    • Peter Kruckow
      :

      Hi Chris
      I can’t say anything about JBH because I’ve never had a dealing with them . The other day we needed something that we couldn’t buy locally ,and we always try locally first to help keep the small businesses in own town (Tambo -Western Qld) operating. Without them we wouldn’t have a town or community. All that aside we tried BigW online , and found an exellent online shop and what we wanted was on special. how good was that. It saved driving 800+ k’s there and 800+ k’s back and was delivered in 3 days. Just looking thru the website if you can’t buy it you don’t need it , I’m not really sure about that but they have a lot of gear to choose from, so I’d say they’ve entered the online business with gusto.
      Hope that helps

      Cheers
      Pete

  27. John Randall
    :

    Hi Roger,
    I have a slightly different view – I never expected JBH to continue growing at such high rates and will be happy to receive higher franked dividends (or other return) that are tax free in my super fund. Using my discounted cashflow model I still have a reasonable margin of safety.
    regards
    John

  28. Pat Fitzgerald
    :

    Hi Roger

    If a business regularly does share buybacks should we add the value of the share buyback to the dividends to calculate a payout ratio ? My reasoning is that the portion of the profits that are being used to do the share buyback are not being put back into the business to compound year after year.

  29. Austin
    :

    Hi Roger,

    I agree with you as you always mentioned, we have only 22 millions people and having 153 store equal servicing 143,790 person per store. In place like US or Japan, Hong Kong or Singapore, 1 store can service a lot more than that. Sad to say Australian retailers are suffering because we have so many shopping centres in one state alone, and retailers have to rent a lot of shops to service their customers!

    Unlike JB Hifi, Oroton, a luxury retailer do not have to be everywhere, they have their target market, and they only have to be in CBD.

    As for now, my favourite retailer is Nick Scali NCK which was at 20% discount when Roger mentioned in November, They focused in NSW and VIC back then, now they have a lot of opportunity to grow – 2 stores rolled out last year. They too have their target market and do not have to rent shops everywhere. Having said that, Roger mentioned that this is a tough business, so i do seek for big discount, which i think we have at the moment, my instrinsic value estimated to be 2.38 in 2011 rising to 2.68 in 2012.
    Rising AUD is helping their business of importing (their margin is a very high 60%+) but sooner or later, cost of buying from China will rise. Tough!

    Of course you would now realise, 3 of those were in Roger’s list during Switzer program back in November. Good Luck Mate! :)

    Regards,
    Austin

  30. Greg Mc
    :

    I have been feeling for a litte while that the IV might come down to meet the share price rather than the share price rising to meet the IV. A feeling mind you.

    The announcement regarding capital management will be important, and as you say Roger, may affect IV. In fact, I strongly suspect that they will be unlikely to come back from their review saying “We’re not going to do anything new”. I do still hold JBH but have been considering my position carefully. Still a great business, but the days of value growth well past.

  31. Andrew
    :

    JB Hi-Fi has definitley entered its maturity phase. The easy growth that it has been finding through store roll outs is likely to have the same affect it has had previously. I predict an increase in payout ratio and i fear that management might try and go on some type of ambitious growth strategy. Needless to say the future will be a good test to see what JBH management is made of.

    Take away the valuation area, it is a great business and is a clear competitive leader. They know what they are and they play to their strengths. I predict ROE to start steadying or declining and an increase in the pay out ratio to do something with the excess cash that it has.

    Adding to this, i predict that JBH will start feeling the affect of online retailing in the home electronics and entertainment centre (a threat and opportunity for JBH INMHO). I think this area is the most at risk of online retailing as people can easily download a CD, buy a game/dvd and even purchase DVD players, game consoles, ipods etc online at potential savings and people know what they are getting already so it is not like they need to make sure the size fits or the quality meets expectations.

    I like JBH as a business and brand but i think the landscape is changing and this business, as you say, is not as good as it once was as an investment opportunity.

  32. Jim
    :

    Hi Roger
    I will be surprised if JB-Hi Fi do a share buyback like CSL. However if it done like BHP’s (ie below intrinsic value) then I would have thought that this would be different.

    I just hope they don’t get any ideas for acquisitions.

    Cheers
    Jim

  33. Ashl
    :

    Hi Guys,

    Re JBH

    I am aware of all the problems with rising POR and declining opportunities but I have learned from past experience not to write off well run companies.

    If they Increase the POR and just keep doing what they are doing then I have IV stabilising at low to mid $20 in a few years time with a nice divvy

    If this is the worst case scenario then it’s not that dreadful.

    After all JBH stores haven’t stopped becoming one of the most busiest stores overnight and it’s not like a new competitor has entered the market overnight.

    If this company was based is the US you would be just piling in ATM given the numbers the company is producing, but alas the growth prospects are slowing in Australia.

    Roger has pointed out the risks in any capital management decision. I.e. an increase in POR or a buyback above IV will reduce current IV.

    There are a few other options as well.

    Like a share buyback at below IV or a really smart acquisition at some stage in the future (if they are patient)

    We have trusted the management to run our business as well as they can so let’s just wait to see what the custodians come up with.

    Just my thoughts

  34. fred
    :

    Hi Roger,

    If JB-Hi Fi was trading at $10.00 it would look good and at $15.00 it would look so so but at $ 20.00 it looks out of place and risky in my opinion. I have never been a great fan of Jb- hi fi !

    Thanks Roger

  35. Geoff Cruickshank
    :

    I looked at JBH right after reading Valuable and wrote myself a story. JBH has been able to employ about an extra 60 or 70 million a year the last two or three years and still maintain a high ROE. Last year it payed off a big slab of debt, about 50m from memory and had about 30 million debt left. Leaving aside a buyback for the moment, with store opportunities tapering, I calculate that payout ratio needs to rise to 65% to leave the company with a manageable amount of increased equity to employ and to keep the ROE over 40%. Under this scenario the POR would have to increase again the next year .. and the problem is the value is struggling to be $20 if that happens (using 12%RR). So my thought is- good buying at $13, but I don’t expect to see it there soon. A buyback near the present price would seem to me a marginal proposition for shareholders, but it will be interesting to see what they come up with.

  36. Tony
    :

    I agree, Roger. The telltale sign for me was the resignation of the longstanding CEO last year.

  37. zoran
    :

    ROGER —JBH

    Thanks Roger , now I understand : If it doesn’t go DOWN it will go UP.

    Cheers
    Zoran

  38. BK
    :

    Growth is certainly going to slow from here.

    But IV for me is around $23. A buyback will certainly add value…so its still a buy for me around these levels.

  39. LukeS
    :

    Hi Roger
    We have heard you singing this opera for a little while now. No sign of the fat lady just yet. Those of us with JBH holdings are all just a little anxious. We can see you are still holding them in valueline so no trigger there.

    In an attempt to think for myself I keep asking the question – how would I feel about owning JBH if tomorrow I was leaving for a desert island for 5 years.

    Would I feel comfortable with not being able to find out anything for 5 years? Will I still have my original capital? Will there be any gain? I would like to think I could at least get my money back. Just want to tell my wife I haven’t lost her money.

    I feel pretty confident about at least getting my money back and I believe there will be a reasonable earn in it as well. May not be the stellar performance of the past but it is still a very good A1 business.

  40. Matt
    :

    Roger given that JBH is currently trading at a slight discount to IV, wouldn’t it be a good time for them to be embarking on a share buy back? I know the discount isn’t what it needs to be to tempt us, but it may be enough for JBH. I don’t see any worthwhile acquisition targets for a business model that works as well as theirs.

    MattB

  41. David King
    :

    Hi Roger

    JB Hi-fi and other retailers are grossly overdoing new store rollouts in this country. Poor old Gerry Harvey, there he is the landlord of a collection of stores that people wander about in checking prices, and wander out again, and that might do better as antique shops. And as their profits decline, what about his tenant lease covenants? And with many of his stores in second tier showroom locations, what percentage of rents now paid by HVN franchisees would be offered by Norm and Madge to run a flower pot shop? As for WOW, have a good look at the way Coles is attacking their soft underbelly, not to mention Aldi, and maybe Costco soon, and then try to imagine another huge hardware store rollout on the way, and the hollow echoes you will hear inside any Lowes or Bunnings once that piece of retail expansion insanity by WOW reaches fruition. I have one retail stock, Oroton, for which thanks, Roger for your analysis. And the linch pin for that stock is Sally M launching into Asia with a top product range, and her good sense in promoting effectively on the web.

    • Grant
      :

      I reckon you are spot on with HVN David. I lived in North America for a time and think that Costco, should they consider our tiny market a target, would significantly impact these retailers. Almost gone are the days when big brands can ensure a retailers exclusivity of product. If JBH moves enough product to ensure it retains brand exclusivity it survives. If Costco sells the same thing for less, off a pallet in a warehouse, then thats where the masses will shop. The big question is “who makes pallet jacks and whats their IV?”.

    • David Sinclair
      :

      Hi David,

      Imagine you have to invest everything you own into either Woolworths or Oroton, then go into hibernation for twenty years. If the company goes bust, you lose it all. Which would you chose? If those were the terms I would not touch Oroton with a barge pole!

      The returns from Woolworths may not be as high, but it could be run by idiots for a long time before it lost its dominant industry position. (Just look at its main competitor, Coles. That company was badly run for a long time and there are still plenty of people who will sing its praises.)

      Put an idiot in charge of Oroton and how long do you think the business will survive? Oroton is currently producing fantastic returns, but who will replace Sally Macdonald when she decides that it is time to move on? The “sleep at night” factor is definitely not as high as it is with Woolworths.

      That said, I think they are both great businesses and I would buy either at the right price. I would just keep a closer eye on Oroton.

      David S.

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