Arguably the best retailer in the country, JB Hi-Fi (JBH) has upset the market again by announcing a forecast full year profit of $100-105 million, some 16% below estimates. The market has not been kind, selling the stock off by 6% at the open, although it has recovered somewhat.
Although sales increased 8.8% in the March quarter, comparable store growth was only 1.3%. Year on year, the picture is worse – comparable growth remains negative at -1.3%, a slight improvement on the -2.2% at the halfway point last year.
The warnings from and around JBH have been quite clear since late last year, not only from downgrades, like this one in December, but also analyst estimates, and of course, being the No.1 shorted stock on the market (and the resulting price action). This torque, like that applied to Telstra as the Future Fund sold its stake, is placing huge medium term price pressure on the stock.
The most important metric to follow here is gross margins, which have continued to deteriorate, down a full 2%, mainly because of deep discounting. Like Woolworths, this does not bode well – negative comparable sales growth and deep discounting does not equal a sustainable earnings growth outlook.
When the company reported half year results in February, I reported:
…a near 10% fall in profit for the first half of the financial year to $79.6 million. However because of the share buyback last year, the earnings per share has stayed steady and a larger dividend can be declared. Sales are up over 5%, yet margins were down and business costs increasing, as revenue rose 5.5 per cent to $1.774 billion.
Although JB Hi-Fi has effectively matured as a business (having grown and opened stores in the most profitable locations) it continues to grow, with 10 new stores opening in the last six months and a total of 16 expected in the full year. It also firmly predicted sales guidance of 5% for the full year, in the face of a deleveraging consumer – a bold statement.
A bold statement indeed – the macro trend of a deleveraging consumer and decelerating credit growth is pushing this fundamentally financial sound business over. The most important lesson in 2011 for me was that identifying superior businesses was moot if you don’t get the macro right. JBH was and continues to be that lesson.
Back to gross margins, with the chart I attached in February, the downtrend (now circa 19%) is obvious (and was over 23% at one stage):
Although the company plans to open another 50 stores over the next 5 years, (10 already open this year), as I’ve explained before, the model is nearing the end of its maturity cycle, a risky reliance on population growth (like all retailers) hindered by the fact that the most profitable stores and locations are already taken.
JBH can remain profitable due to its superior capital management and market leading status, but as this chart shows, comparing the share price to earnings per share (actual and revised forecasts) even with a share buyback, the ability to grow earnings per share is being curtailed:
There remains hope with JBH, fundamentally its very well run, has excellent capital management, its online business is growing and the competition is being hit harder, with Dick Smith on the chopping blocks at Woolworths, WOW Sight and Sound going into administration (and JBH looking to snap up the store locations…) and Harvey Norman (HVN) struggling in the 20th century.
The stock also looks cheap, with metrics like a dividend yield of nearly 11% (fully franked) and a P/E ratio of just over 10 times, although I contend this is still too high – 8 to 9 times is more comparable for this stage in the macro cycle and to offset the risks inherent in a bear market.
Even though a stock may look cheap, prudent risk management and a continuation of the current macro trend shows that an allocation at this stage is very risky, although a drop in rates may have the consensus crowd reversing their medium term opinion on retailers. On that note, other retailers have dropped on the open, with Harvey Norman (HVN) the worse off, down 3.5% and Myer (MYR) down 2.5%