Will FY22 Be Different For Harvey Norman?

This story features HARVEY NORMAN HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: HVN

A year of strong earnings and profit growth provide challenging comparables, so will Harvey Norman perform differently in FY22?

-July/August sales not likely to be a good indicator of the unfolding year
-Does Harvey Norman's premium status limit online business?
-Offshore expansion and property investment differentiate the business
 

By Eva Brocklehurst

Harvey Norman ((HVN)) has had a good pandemic so far, with earnings from franchising operations up strongly in FY21, supported by margin expansion. Yet will the tough comparables provide obstacles to growth in FY22? Will the current financial year, which has started with major lockdowns in Australasia, be different?

The start of the first half of FY22 has been affected by rolling lockdowns, with Australian franchisee like-for-like sales down -19.1%, as 58% of the population went into lockdown.

Malaysia, the most negatively affected by lockdowns in the international business, commenced FY22 in lockdown and has only just started to re-open. New Zealand went into level 4 lockdown in August with no click & collect permitted, although contactless home delivery is allowed.

Yet Citi does not believe the July/August sales figures are reliable for forecasting the unfolding year as the fundamentals underpinning the business, such as housing demand, remain solid.

The broker believes pent-up demand following the lifting of restrictions as well as more general mobility will mean sales rebound. Hence, the June quarter exit sales are probably a better underlying indication of demand rather than the recent July/August period.

In that instance sales momentum remained steady. Hence, the broker considers the lockdown-induced declines a temporary "speed bump" for household goods retailers. That said, the broker points out costs are starting to rise and Harvey Norman could experience a reversal of the operating leverage enjoyed in FY21.

Harvey Norman is keeping more inventory in the light of persistent disruptions to the supply chain and ahead of what is expected to be a record Christmas. Credit Suisse notes the potential impact of this enlarged inventory on profitability, yet assesses the strength of underlying demand means the risk is quite small, unless lockdowns extend to the end of the year.

Yet Jarden suspects, as the business cycles strong results and competition re-accelerates, there is a risk for the Australasian business, although strength offshore should mitigate some of the risk.

There was a moderation in sales in the second half of FY21 with franchisee sales declining -0.5%, primarily because of the cycling of comparables in the second half of FY20. Moreover, when compared on a 2-year basis, Singapore and Malaysian sales are still significantly below pre-pandemic levels, Macquarie points out.

Yet pre-tax profit outside of property revaluation was up 66% in FY21 and Australian franchisee comparable sales were up 12.9%, supported by the homebuilder grants. Franchisee operating margins expanded to 9.04% and all geographies posted growth with the overseas retail segment pre-tax profit up 58.3%. Sales in New Zealand surpassed $1bn for the first time.

Macquarie suggests pent-up demand from limited ability to travel, complemented by strong property market, has supported sales growth in New Zealand.

At the category level, strength in home upgrades was broad-based amid strong demand for kitchen products, audiovisual, furniture and bedding and growth is expected to return in the second half of FY22 as consumers reinvest in their homes. As a result, UBS is confident housing strength will support sales growth in franchising operations and help cycle the pandemic-boosted sales period.

Online

Macquarie was disappointed there was no disclosure on online sales despite click & collect operating from 192 franchise complexes in Australia. It appears, Credit Suisse observes, delivery is 5% of customer orders and around 95% of customers still go to the nearest store for click & collect.

UBS makes the comparison with JB HiFi ((JBH)), which appears to have a much more successful online presence, particularly the company's The Good Guys brand, which has a closer product range to Harvey Norman.

The broker explains, as Harvey Norman has a premium focus, it requires store attendance and this reduces the extent to which sales can be transferred to online. One of the areas of strength of The Good Guys has been premiumisation and on this aspect, UBS notes, the business continues to trail Harvey Norman.

The broker also notes the category mix for Harvey Norman requires impetus from housing construction and this activity has been significantly held back in several areas recently, and a more permanent shift to working from home along with robust dwelling construction and renovations should support the category for the next 2-3 years.

Nevertheless, UBS is cautious about retailing and questions whether, post lockdowns, consumers will spend as aggressively as they did in 2020. Government support is more modest, the main reason for being cautious.

Citi agrees with this assessment, given the impact to housing completion and furniture demand from restrictions to construction activity and the fact premium furniture, which Harvey Norman targets, is not as conducive to online purchases.

Capital Management

Jarden suggests a key catalyst would be capital management, which could occur when economies re-open and working capital normalises although this is unlikely in the first half. The broker calculates at $300m off market buyback would be 4% accretive in the first full year.

Credit Suisse also notes some disappointment at the results because of the lack capital management but had always suspected cash would be used for expansion. The broker believes offshore expansion and the property segment differentiate Harvey Norman from its household goods peers in Australia.

This may create debate among investors. The freehold property portfolio remains significantly undervalued and, on a long-term view, that value is unlikely to be reflected in market valuations of Harvey Norman under the current strategy. Hence, the broker believes this aspect of the stock is likely to be a consideration for the true long-term investor.

International

The growth of international could mean this segment achieves 30% of operating earnings (EBITDA) by FY24 and there is significant long-term growth potential. There are plans to enter Hungary in 2023, which Macquarie considers is a natural fit given Harvey Norman's presence in bordering countries.

Up to six stores will be rolled out in FY22, three in Australia and three internationally (Malaysia, Croatia, Ireland), and up to 12 stores will be rolled out in FY23 with two in Australia and 10 overseas (four in New Zealand, three in Malaysia and one in Croatia).

Jarden, not one of the seven stockbrokers monitored daily on the FNArena database, has an Underweight rating with a $5.40 target. The database has four Buy ratings and two Hold. The consensus target is $6.18, suggesting 14.9% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 5.9% and 5.7%, respectively.

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