Retailing Headwinds Buffet JB Hi-Fi

This story features JB HI-FI LIMITED. For more info SHARE ANALYSIS: JBH

Margins remain the core issue for brokers in assessing the outlook for JB Hi-Fi as it beds down the acquisition of The Good Guys.

-Sales trends need to improve to meet guidance
-Near-term outlook determined by sales growth in JB Hi-Fi Australia
-Gross margin remains under pressure at The Good Guys
 

By Eva Brocklehurst

Conditions are tough for JB Hi-Fi ((JBH)) despite a solid FY18 result in its core Australian business. The company has made a soft start to FY19 trading and brokers remain concerned about the pressures on margins at The Good Guys. FY18 sales of $6.85bn were in line with consensus and guidance and FY19 revenue guidance is for growth of 3.6%, in line with expectations.

Sales growth in July for JB Hi-Fi Australia was 2.9%, while New Zealand slipped -2.1%. Sales growth for The Good Guys was 2.7%. JB Hi-Fi Australia sales guidance implies footprint growth of 1.6%, amid smaller format stores.

Credit Suisse forecasts declining operating earnings in FY19, flat sales and increasing promotional intensity and believes the near-term outlook will be determined by sales growth in JB Hi-Fi Australia. Sales guidance appears conservative but the broker points to the cycling of the 7.8% growth achieved in the first half of FY18, and the fact the company faces few opportunities for new product launches in the first half.

The full year dividend represents a 65% pay-out ratio and Morgans suspects there is certainly upside to pay-out in the medium term, although the board is noticeably cautious as it seeks to incorporate The Good Guys and monitor the progress of Amazon in Australia. While the base business faces competitive headwinds the broker considers it reasonably positioned.

Trends need to improve to meet guidance and this may not eventuate if competitive intensity increases further, UBS assesses. The broker retains a Neutral rating, given the few catalysts on the near-term horizon.

Citi, on the other hand, has a Sell rating, believing the outlook is challenging. The broker highlights a decline in underlying sales momentum at the Australian operations to 2.6% in the second half of FY18 from 5.3% in the first half.

Morgan Stanley considers JB Hi-Fi's valuation is deeply discounted, while there are multiple drivers for earnings across FY19-20. The broker also believes the market is taking an overly cautious view of the exposure to a deteriorating housing cycle and Amazon. This fails to reflect JB Hi-Fi's track record, where market share gains have been made and the product offering has been transformed.

Margins

Gross margins at The Good Guys fell by -200 basis points in the second half, with Citi noting the appliances industry remains highly competitive. The broker estimates that category alone sustained a reduction in gross margins of -300 basis points. Citi expects -120 basis points of gross margin contraction in the first half, although accepts The Good Guys is taking action around incentives.

Morgans forecasts productivity on operating costs should broadly offset the need to invest in price, finding it hard to believe a case will not be made for price investment in FY19 and beyond. The broker expects lower divisional gross margins to be offset by cost of doing business (CODB) improvements, while incremental synergies should provide majority of the margin expansion expected in FY19.

Gross margins among the divisions were higher than Morgans anticipated within the JB Hi-Fi network but lower in The Good Guys because of heightened promotional activity. Management has confirmed it has banked the guidance for $5m in synergies in FY18. Morgans would prefer some stabilising of the margins within The Good Guys before becoming more positive.

The Good Guys

Credit Suisse suspects the unique nature of The Good Guys is lost, as inevitably its performance is compared with JB Hi-Fi. There is now a far greater emphasis on consumer electronics within The Good Guys, potentially explaining some of the weakness in JB Hi-Fi comparables in July. The broker suggests the most productive consumer electronics format is JB Hi-Fi and trying to mimic that success with The Good Guys appears detrimental overall.

Morgan Stanley acknowledges the surprise downgrade to forecasts early in May had an affect on confidence, especially regarding its ability to improve the performance of The Good Guys. Yet greater insight into the strategies such as re-configuring store layouts and improving supplier engagement, makes the broker more confident that gross margins should improve.

Morgan Stanley notes JB Hi-Fi in New Zealand continues to be a work in progress but recent actions of closing stores and re-branding should narrow the expected loss in FY19.

While the margin declines for The Good Guys have been greater than Macquarie anticipated the outlook remains positive. The broker expects a combination of benefits from a coordinated support office, supplier driven price inflation and merger synergies will support system earnings growth in FY20 and beyond.

Citi revises The Good Guys earnings forecasts higher on lower costs, which drives 3-5% upgrades to net profit estimates for the group, yet still expects gross margins will come under pressure in the first half.

Ord Minnett agrees the acquisition of The Good Guys has been challenging, both in terms of the external environment and execution, and that synergies, while positive, are finite source of upside.

FNArena's database shows three Buy ratings, three Hold and two Sell for JB Hi-Fi. The consensus target is $25.61, suggesting 6.5% upside to the last share price targets range from $21.30 (Citi) to $32.00 (Morgan Stanley). The dividend yield on FY19 and FY20 forecasts is 5.7% and 4.6% respectively.

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