Harvey Norman is generally seen as a struggling retail stock but because of its franchise structure it is just as much a commercial property play. This is the point made by UBS, which has a buy on the stock and a price target of $2.20.
“We continue to see value in HVN’s ~$2.1bn property book ($1.43 per share un-geared), implying a value of ~55cps for the operating business which UBSe should generate an un-levered EPS of ~12.7cps in FY13, implying an un-geared PE of just 4.9x. The above said near-term earnings uncertainty and the lack of capital management and / or partial sale of property (to crystallise value) may limit outperformance. We maintain our Buy rating on valuation grounds.”
Commercial property depends on the health of its tenants, the point that Merrill Lynch makes. It has an underpwerform rating and a much lower price target of $1.45:
“There has been a sustained deterioration in HVN’s key Franchising business for some time (which today does not look like is improving). Its business model is coming under increasing pressure in the current climate – as its ability to take a franchisee fee is becoming more difficult (in line with falling franchisee profits), while its need to provide tactical support to its franchisees is growing. We do not see any reprieve in the near term.”
These are the cross currents when valuing the company. Net debt to equity is 21%, but return on equity is only 7.7%. In other words, low gearing but low income. And the income is likely to worsen, which is the point that Credit Suisse makes:
“Although our valuation is supported at current levels of profitability it is worth noting that we don’t explicitly taken into account credit risks associated with franchisees. HVN had $1.3bn in accounts receivable at 1H12 which were largely associated with funding franchisee operations. HVN has not made the financial position of franchisees particularly transparent.”
That opacity is a problem. When one considers the prospective earnings multiple is about 13 times, it is not a bargain. And the uncertainty over Australian retail is not about to go away, with the currency rmeaining high and the pressure of the internet growing. The prospective dividend yield of 4.6% is perhaps the biggest positive around the stock