Harvey Norman came in with a bit of a shock result, with sales for the first half down 6.3%; and second quarter sales down 8%. A big fall. There was a 2.4% drop in net profit after tax to $130.8m, which was aided by a more favourable tax rate of 20%, down from 32%. Pre-tax profit fell by 18%. Margins have fallen sharply in the Australian franchising operations. It is a grim story, but of course that can be the best time to acquire. Deutsche has a buy and a price target of $2.70:
We value Harvey Norman using a DCF (WACC 10.3%, Tg 2.0%) because we think it best captures the value of the cash flows generated by the Franchising, Retail and Property operations as well as the investment required. Downside risks include: weaker consumer spend that anticipated, further losses from offshore businesses and newly acquired operations and the entry of Masters.
I’ll say they are the downside risks. The investment question is how much protection does the property holdings give? Deutsche likes the story:
With property increasing in value relative to FY11, the share price drop implied a sharp decline in value attributed to the retail business. Conditions are likely to remain difficult but even after applying a 30% discount to property, the implied retail EBITDA multiple is only 3.4x FY13.
Of course, Harvey Norman is getting hit by the retail downturn, so it is boosting its property story. The portfolio is valued at $2.12bn, which equates with $2 per share. Trouble is, retail property valuations are likely to come down as retailers pull back on store numbers. The property story and the retail story can’t really be separated so easily.