International Growth Buoys Harvey Norman

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Harvey Norman's Australian franchise has returned to positive sales growth since September, yet brokers remain cautious ahead of the all-important Christmas trading period.

-Competition in Australian market still likely to intensify
-Store expansion internationally should support growth
-Key risk is franchisee margins in Australia
 

By Eva Brocklehurst

Sales growth at Harvey Norman's ((HVN)) Australian franchises has improved in recent months, albeit still lagging well behind the international portfolio. All divisions have improved and the core Australian franchising operation has returned to positive sales growth since September.

Australian franchisee sales declined -1.3% over the financial year to date, slightly better than the first eight weeks where sales were down -2.0%. Aggregated sales were up 2.7%, assisted by currency and reflecting strong results in offshore operations. Malaysia was up 32.4%, Ireland up 20.9%, Slovenia/Croatia up 8.8% and Singapore up 3.2%. New Zealand sales were up 4.5%.

The company did not include any margin or earnings guidance in its update or any commentary regarding the Black Friday sales or the outlook for Christmas trading, which will be critical. Citi is surprised the run rate of like-for-like sales growth has improved in Australia, given the headwinds from a slowing housing sector and cooler weather that affected seasonal sales.

The broker is also cautious about the level of promotional investment across the industry that has been deployed over the past 12 months, which now must be cycled. Retaining a Sell rating, Citi still envisages earnings risks to the downside.

Competition in the Australian market will only intensify, Macquarie believes, amid a moderation in housing activity. Therefore, the need for ongoing investment will only increase. The broker acknowledges upside to its target, largely because of the real estate component of the valuation, while the path towards crystallising this is unclear.

Ord Minnett points out comparables are difficult to analyse. December 2017 was a strong month as a result of an underwhelming launch by Amazon that bolstered sales for Harvey Norman. Still, progress so far in the first half is ahead of its forecasts.

International

Like-for-like sales growth remains strong in international business and the company is targeting a 20% expansion in its store network in the next two years. Macquarie believes, while this should support growth, it remains a source of higher risk.

International business, while not large enough to offset the weakness in Australia, is showing the benefits of diversification. Credit Suisse asserts, while company has often been criticised for poor capital allocation, allocating capital to growth in Asia appears to be reasonably good decision.

While struggling to envisage the stock outperforming during the housing market downturn in Australia, international does offer some downside protection, the broker adds, also noting there is a level of support from alternative use of the company's Australian property portfolio

UBS is cautious about the consumer outlook but, given a 9% dividend yield and the diversification that comes from the international business, retains a Neutral rating. The broker now forecasts 14% growth in international operations in FY19.

Margins

In Australia, UBS believes the key risk is franchisee margins, forecasting a decline to 3.9% in FY20. In past downturns, Australian franchisee margins have fallen to around 2.4%. The broker believes the outlook for Harvey Norman is challenged, as competition is intensifying amid a shift to online business. Credit Suisse considers Harvey Norman better protected from industry changes than JB Hi-Fi ((JBH)).

Australia may not be as strong as it was in the past, but Deutsche Bank believes this is not a disaster, and offshore business, now one third of earnings, as well as resilient property earnings, should drive growth at a group level. The broker believes the market is incorporating a scenario that is too dire.

There is one Buy rating (Deutsche Bank) on FNArena's database, with four Hold and two Sell. The consensus target is $3.64, suggesting 16.8% upside to the last share price. The dividend yield on FY19 to forecasts is 8.8% and on FY20, 7.8%.

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