Harvey Norman catches the electric blues

Last week it was JB Hi-Fi, today it's Harvey Norman. There is a bloodbath occurring in the electrical goods sector and, while the two big retailers have taken different approaches to it, they are both suffering badly.

In last week's trading update JB Hi-Fi disclosed strong sales growth for the nine months to end-March – 8.8 per cent – but comparable store sales growth of only 1.3 per cent. More to the point, it revealed that where it has lost 30 basis points of gross margin in the first six months, gross margin was down 200 basis points in the March quarter. It is now flagging an earnings slump of between 22 per cent and 26 per cent for the full year.

Today Harvey Norman announced a 6.7 per cent decline in global sales for the nine months to March and a similar fall in comparable store sales. In its Australian operations sales were down 7.5 per cent for the nine months (6.9 per cent on a comparable stores basis) with a 9.2 per cent fall in the March quarter following a 10.2 per cent fall in the December quarter. April sales had continued the third quarter trend, the company said.

It said its unaudited accounts for the nine months indicated earnings of $204.8 million against the $272.3 million it generated for the same period last year, a 24.8 per cent or $67.5 million fall. Pre-tax earnings have been falling steadily – they were down 19.3 per cent in the first quarter and 16.7 per cent in the second before plunging 43.9 per cent in the March quarter.

There is no mystery as to why the companies are struggling. The entire retail sector is experiencing its most prolonged period of real sales declines in memory.

In terms of the broader retail environment, that's attributable to the new-found conservatism of consumers, their unwillingness to pay full price and the rapid growth in online retailing.

There are, however, particular and quite acute pressures on retailers of audio visual products and information technology products, where the strength of the Australian dollar and the change in consumer behaviour have combined with the historical trend of falling real prices for technology to ignite substantial price deflation.

That in turn has led to otherwise irrational behaviour by retailers trying to defend their volumes and to shift stock almost regardless of price. The collapse of WOW Sight and Sound and Woolworths' downsizing of the Dick Smith chain in preparation for its sale have added to the destabilising of the sector.

The JB Hi-Fi response to the conditions has been to maintain its quite aggressive store opening program and to continue to compete on price. That's protected its sales but damaged its margins. Harvey Norman has shed some sales but will still end up with a very similar reduction in earnings.

The Harvey Norman profit slump is despite quite solid growth in its European operations and its appliances and whitegoods categories and steady sales in its furniture and bedding business, which provides some indication of just how severe the competitive intensity is within the audio visual and IT categories.

Both JB Hi-Fi and Harvey Norman are pinning their hopes for recovery on some moderation of the unsustainable discounting as the weaker industry participants disappear from the market. JB Hi-Fi's Terry Smart has said he believes the level of discounting is a cyclical rather than long-term structural phenomenon.

There are, however, some structural elements to what is occurring, not the least of it the extent to which online retailers, local and international, are pushing into the high-value branded electronic products space, which will create permanent pressure on prices and on the industry structure.

The changes in consumer behaviour and their focus on price might also have structural elements. After two decades of prosperity (and annual credit growth in the mid-teen percentages) the economy has entered a period, likely to be a lengthy one, of deleveraging and low-growth.

There is an argument, however, that the retail sector generally has far too much capacity. With retailers in their sector disappearing or downsizing and no signs of the pressures easing there is some rationalisation and consolidation of the sector occurring and likely to continue to occur that might both reduce the intensity of the competition, slightly, and redirect some sales activity towards Harvey Norman and JB Hi-Fi.

Any abatement in the intensity of the environment which they are trading is, however, unlikely in the near term. They are in for a tough period, with realistically no prospect of a return to the environment they once regarded as normal.