Harvey's search for retail relief

It was no surprise Harvey Norman's earnings sharply decreased in the December half, and the group may not be able to fall back on its strong and stable property portfolio as the retail landscape changes.

It was no surprise that Harvey Norman experienced a sharp downturn in earnings in the December half, given the continuing weak retail environment and the particular pressures in the electronics segment.

The 17.7 per cent decline in pre-tax earnings was reflective of Harvey Norman’s positioning within a sector where overall sales have been very weak as consumers remain in a very defensive posture and where the electronics segment in particular has experienced significant price deflation because of the strength of the Australian dollar, the ferocity of the competition and the incursions of online retailers.

Today’s retail sales and credit data provided no relief, with eastern seaboard sales still sliding in January and credit growth still very modest.

For Harvey Norman, the recessed conditions were reflected in revenue from its franchisees that fell $24.3 million because their sales were down six per cent, an additional $65.2 million of working capital advances to the franchisees and higher levels of ‘tactical support’ to enable them to compete. The group’s franchise business incurred a 36.5 per cent fall in pre-tax earnings, from $150.4 million to $95.5 million.

Harvey Norman’s company-operated stores were affected by the closure of Clive Peeters stores but reduced their losses from $6.9 million to $1.14 million, while the major positive in the result was a 46 per cent increase in pre-tax profits from the group’s property operations, although that included $11.9 million of property revaluations.

Gerry Harvey had two major themes in his response to the result. One was to stress the uniqueness, for a retailer, of the group’s $2.1 billion property portfolio and the other was a focus on the group’s ‘omni channel’ strategy.

Harvey has been a late and reluctant convert to engaging with the enemy by boosting his group’s online presence – until recently he was devoting his energies to trying to convince the federal government to removing the exemption from GST of overseas purchases of less than $1000.

Now, along with the other major retailers, Harvey Norman is developing a multi-channel strategy and beefing up its online marketing and engagement with social media. With online sales still only representing about five per cent of retail sales, albeit growing strongly – annual growth of nearly 20 per cent according to NAB’s inaugural online retail sales index – the major retailers have time to get into the game.

Harvey says the group’s property portfolio provides strength and stability for its balance sheet, reliable income flows and a distinct advantage over competitors whose assets are goodwill, brands and trademarks.

Perhaps so, at least for the near term.

His competitors, however, have started to re-think their own strategies for their physical store networks. Just Group, Myer, David Jones and others are re-considering the traditional growth strategy of increasing sales by adding stores to their networks. Indeed it is possible, even probable, that over the next few years the major retailers will shrink their retail footprints to focus on their most profitable stores as online retailing takes a greater share of sales and renders more stores marginal.

They are already having a different kind of negotiation with landlords to those they had in the past when leases neared expiry, seeking reductions in rents or other financial concessions before they renew in order to improve their stores’ competitiveness. The fact that they don’t own much property affords them some flexibility to adapt their business models.

There is a realisation that the changes occurring in retail, while they may have a significant cyclical element at present, also have an emerging and accelerating structural dimension that will affect traditional retail business models – and the model of ever-increasing rents that has under-pinned retail shopping centre ownership.

Given that the Harvey Norman franchisees have significant exposures to some of the categories most vulnerable to the self-reinforcing combination of the high Australian dollar and surging online sales the Harvey Norman property portfolio, while providing some stability and rental income streams into the medium term, could limit the group’s flexibility and might ultimately be threatened by the structural changes in retail and retail property that could develop.