BUY HOLD SELL – JB Hi-Fi (ASX: JBH)
JB Hi-Fi (JBH) operates 319 stores across Australia and New Zealand under the JB Hi-Fi and The Good Guys brands. It is recognized as the biggest player in the Australian consumer electronics and home appliance market, posting AUD$9.8bn in FY21. JB Hi-Fi Australia is the main revenue contributor at 67% in FY21, The Good Guys at 30% and JB Hi-Fi NZ at 2.7%. The group’s operating model focuses on four pillars which include: scale, low-cost operations, multichannel capability (in-store, online or over-the-phone fulfilment) and people and culture.
Key earnings drivers
JB Hi-Fi Australia is the group's main earnings driver, The Good Guys second, then JB Hi-Fi NZ, making up the balance with only a small contribution in FY21. COVID-19 and the Work-From-Home transition proved to be beneficial for JB Hi-Fi with heightened customer demand for consumer electronics and home appliance products. Total sales grew by 12.6% to AUD$8.9bn over the year in FY21, supported by exceptional growth in its online segment. Online sales in HY22 totalled $1.1bn, up 78.1% over the year. A disciplined focus and continued investment in Online was touted in its May update at the Macquarie Australia conference. The shift in consumer behaviour to e-commerce fuelled by the pandemic and management’s ability to benefit from that dynamic played, and will likely continue to play, a crucial role in operational performance.
An appetite for capital management contributed to EPS improvement, although it is unlikely to result in full-year EPS growth this financial year. In February, JBH returned $250m via an off-market buyback. The return of surplus capital highlighted confidence from management that it can meet its financial objectives and emphasized JBH’s ability to generate robust cash flows. The leftover surplus cash that wasn’t contributed to the buyback leaves the door open for possible M&A opportunities. Cash of AUD$263m sitting on its balance sheet at the end of June.
The share price is down 17% since the start of the year but is starting to show signs of life. The stock is up 9% since its June low. RSI and MACD forest highlighting positive momentum heading into results on August 15. The 4000c level is expected to offer support.
Morgans believes the retail trading environment will deteriorate in FY23 due to inflationary impacts on household budgets, but notes JBH remains cheap on valuation measures. JP Morgan said much of the negative retail outlook in Australia has been priced in. The average broker target indicates upside of 10%.
Despite JB Hi-Fi holding a market leading position and its pandemic resilience, it operates in the consumer discretionary sector, which is experiencing several headwinds. Strong pandemic sales growth is unlikely to be repeated in the medium term. Slowing economic growth and higher interest rates are expected to erode margins further. Gross margins were down 21 bps to 21.8% in HY22. Margin compression, higher labour costs, supply chain disruptions and higher inventory levels the likely commentary expected to colour full-year results on August 15 and feature in future periods. No guidance for FY22 offers little confidence and uncertainty in the outlook.
The RBA believes economic growth will slow to 2% in June 2024, which will likely have an outsized negative influence on the consumer discretionary sector. High savings ratios and strong consumer balance sheets will provide a buffer, but higher interest rates and consumer prices are expected to outweigh those tailwinds. Shrinking household budgets and changing spending habits are expected to make JBH’s offering less attractive. EPS growth is expected to reverse 4% this year and continue to fall away until FY4 (FY25) as the RBA removes extraordinary monetary policy measures.
The Good Guys segment is also expected to underperform in a slowing property market as demand for new appliances and white goods is diminished. Property values across all major Australian cities fell sharply just days after the RBA started its rate hiking cycle in early May. The Good Guys total sales for HY22 declined by 0.8% to AUD$1.44bn. Competition headwinds also follow JBH with the entrance of Amazon Australia of recent concern. The reinforcement of online retail means JBH’s store model is under pressure as online platforms operate with very low operating costs, a 24-hour shopfront and no need for expensive shop leases or staff. Given the narrow economic moat and limited to no ability to sell products at a premium, margin pressure concerns are lingering.
Chart of the Forward PE (blue) against the share price (orange).
Chart of the forward yield before franking.
While JB Hi-Fi does not appear to offer much of a compelling investment case as interest rates rise and as consumer spending peaks after two years of pandemic boom. We are in the wrong part of the economic cycle for JBH, and that is reflected in the depressed share price in the short term. Long term it is presenting an attractive opportunity to buy one of the best retailers in Australia at a discount to its peak PE ratio (20x) and its long term average (13.73x). Now on an 11.7x forward PE. It also has an over 9% yield including franking. JBH has a proven management team that has a history of returning value to shareholders and a track record of acquiring businesses and extracting value, take the Good Guys deal in 2016 for example. JBH has a significant level of cash on its balance sheet and may look to take advantage of the current weakness in the consumer discretionary sector to make opportunistic acquisitions which could re-rate the business. Slowing economic growth and higher interest rate are obviously a headwind but some level of negative sentiment is priced in as is slower revenue and earnings growth. The asymmetry of risk sits to the upside for JB Hi-Fi long term, we just may be able to time it a bit better. Low PE, high yield. When the market bottoms it is a solid BUY. There is also a short-term buy signal on the chart. First sign of a bounce and it was bought. When the market bottoms properly, it will be a solid recovery play.