JB unwraps a touch of optimism

The JB Hi-Fi trading update today has introduced a touch of optimism to a discount retail sector that had been destabilised by the disappointing updates of Super Retail Group and The Reject Shop.

JB Hi-Fi has reported 6.8 per cent uplift in total sales and a 2.8 per cent rise in comparable stores sales for the December half and forecast a 10 per cent increase in net profit to $90.3 million. Both its gross margin and EBIT (earnings before interest and tax) margin improved during the half.

Shares across the discount retail sector had fallen after Super Retail and The Reject Shop issued their trading updates.

While Super Retail experienced solid sales growth and forecast a modest increase in earnings it described the overall result as being “below expectations” -- and the sharemarket response confirmed that it was.

The Reject Shop had a massive increase in total sales, which were up 17.7 per cent after it opened 33 new stores, but its comparable stores sales were flat and the earnings guidance was for a profit of between $16.6 million and $16.9 million compared with the $20.1 million in the previous corresponding half.

The market responded quite savagely to the Super Retail and Reject Shop results because they were at odds with both the objective and anecdotal evidence of a relatively buoyant Christmas trading period for retailers.

The JB Hi-Fi result provides reassurance that good retailers have been able to translate the stronger consumer spending through the Christmas period into profits.

JB Hi-Fi is, of course, a somewhat unusual discount retailer with a very strong brand within what might normally be considered a price-driven sector.

Despite a material exposure to the retail segment most affected by the tough post-GFC conditions – electronics – it has maintained an aggressive growth strategy and concentrated on protecting its sales base even when its margins were being stressed by the environment and the disruptive actions of distressed competitors.

With the disappearance of a number of competitors and Woolworths’ sale of the Dick Smith chain after a restructuring that added to the pressure on margins in the sector, competition in the sector, while still intense, has been more rational and JB Hi-Fi has benefitted.

The group has also shown that it has an ability to execute, whereas both the Super Retail and Reject Shop updates contained confessions of some management failures, with Super Retail saying that its execution had not been up to the standard it expected while the Reject Shop had some product mix and excess inventory issues.

It may have helped JB Hi-Fi, relative to its peers, that its retail offer is relatively focused and that it isn’t going head-to-head with the larger and more general discount retailers like Kmart and Big W.

Kmart has trebled its EBIT margin over the past four years on a stagnant sales base by slashing its range and using deep discounting to drive volume through the more focused offer. That has proved to be a very disruptive model for the discount department store sector (including its Wesfarmers’ sibling, Target) and the sector’s suppliers. More recently, Woolworths has re-focused its Big W chain, with some positive results.

From the updates of the three discount retailers it is apparent that there were more sales dollars available over the Christmas trading period. As the updates and results continue to flow what will separate the better retailers from the rest will be their ability to do what JB Hi-Fi has done and ensure that some of that top-line growth flows through to their bottom lines.

The next challenge for retailers generally will be the sharp fall in the Australian dollar – it has fallen about 3.5 cents in the past fortnight – and whether or not they can either pass on the higher cost of imports to consumers within a still difficult retail environment or find other ways to offset the impact on their gross margins.

With most of the bigger retailers having moved towards direct sourcing models the impact on their competitiveness and profitability could be quite significant, as could the impact on labour costs of the transition to the “modern” retail award and its higher penalty rates.

The post-GFC period has been very challenging for retailers. Even if the apparent modest opening of their wallets by consumers over Christmas is maintained, that’s unlikely to change.