MARKETS SPECTATOR: JB Hi-Fi erosion

Bank of America Merrill Lynch has downgraded its recommendation on the JB Hi-Fi group to 'underperform' from 'neutral', due to a tougher margin outlook over the next few years.

The broker believes that industry margins are falling and are likely to continue to do so as key competitors in the industry are willing to work off lower margins than JB's current margin, with peers matching or even cost-cutting JB's prices.

This is leading to JB's key competitive advantage, its value proposition, being eroded in BoAML's view.

"While we initially thought falling industry margins (from irrational discounting) would be somewhat short-lived and likely lead to consolidation, we now expect margin pressure to remain a more permanent feature. This is especially the case with Harvey Norman continuing to ramp up tactical support (to its franchisees) and Dick Smith undergoing a recapitalisation (off a very low base)”, the broker said.

Given the industry dynamics, the broker believes JB HiFi's relatively high margin is unlikely to be sustained relative to its peers. There really doesn't appear to be a solution for JB apart from reducing its prices to compete with its competitors.