This is an article aimed squarely at my hedge fund manager readers who regularly ask me what to short in Australia. The most obvious target (in my view) is retailers – and as a taster I start with the big-box consumer electronics retailers.
Australia still has two electronics chains doing big-box consumer electronics. These are JB Hi-Fi which is well-run, has a modern format, a short history and not much balance sheet and Harvey Norman which is a little more old-fashioned (like Circuit City in the 1990s it still sells fridges on prime real estate) but has a better balance sheet (reflecting its once glorious history). Harvey Norman also has a franchise model – it does not own all of its stores.
In the US, the debate is whether the country can support one or zero highly profitable big box chains. Best Buy – the bears argue – is the showroom for Amazon. In Australia, as I said, we still have two chains – it’s as if Circuit City were still around. Moreover because Harvey Norman has a balance sheet it can survive quite a long time and Gerry Harvey is prone to say it is the competitor that will go out of business. But Harvey Norman really is losing share to JB Hi-Fi and ultimately both will lose share to the internet.
Gerry Harvey sounds somewhat desperate these days – firstly arguing that internet shopping is a con (nobody makes any money in it) and then arguing that there should be additional taxes on it. Then he sets up an internet company in Ireland. It looks really bad except that because of the above-mentioned balance sheet, he can stay around for a while and he might even be able to liquidate and be left with something valuable at the end. (I still believe liquidating a large retailer is incredibly hard.)
The JB Hi-Fi model
JB Hi-Fi spends a lot of money to look cheap. Have a look at their website – it is almost a parody of old-style discounting pamphlets. The stores have false plywood floors to make them look like a discounting house. They have young staff wearing casual clothes and signs that are carefully printed on a computer so that they look hand-drawn. The shop is deliberately cluttered giving it a feeling of being (very) crowded. They don't do products that are not hip. There are no fridges, blenders, toasters, but lots of pads, laptops, large screen TVs and computer games. The Apple products are given prime placement, not because selling them is profitable but because it makes the store look cool.
And for a long time JB Hi-Fi really was cheap. The website flashes the slogan "cheapest prices – always". This was a company with the virtuous cycle of looking cheap and being cheap, selling fast, having high turnover and low inventory costs (important in electronics where obsolescence is quick) and just looking like a happening place. It was also a hot stock.
But it does not ring true anymore. They are not the ‘cheapest prices always’ – far from it. They match prices on large items where people price check and they will match prices if you really push them (trade practices law in Australia makes it hard to advertise the cheapest price if you don't have it), but I am noticing that on ‘convenience items’ such as cables and SD cards they are pricing aggressively high. They spend money to look cheap but they aren't any more. It is the advertising tag-line of a decaying business.
They missed earnings expectations a while ago – the stock is having a rough time. But it is still fairly richly valued (do comparisons of price to sales if you want). The immediate question is how far further will it go and will Gerry Harvey keep throwing his good balance sheet at staying in the game and give them pricing pressure. Gerry Harvey, it seems, wants to be the survivor.
My Christmas Observation
I purchased a camcorder at Christmas and forgot to buy an SD card. These produce a lot of data so a big (ie 32gb) card was required.
The only such card at the JB Hi-Fi in the major shopping mall in Bondi Junction was priced at $299 for the 45 mb/s version. The same product via an Amazon partner store cost $128.
Gerry Harvey doesn't do better. A 32 gb a Sandisk "ultra" card at the Harvey Norman in the same shopping centre was priced at $190. Amazon will sell you an identical product for $39.
I am trying to work out the dynamics of this with regard to the stock. My best model is the decline of Radio Shack which did this before them. Radio Shack had a business model built on squeezing very fat margins out of customers that needed something now. They had 2400 stores over America so they were close enough to anyone who needed them pronto.
And proximity was useful. Remember the days you absolutely needed that Firewire cable and were prepared to drive to the local Radio Shack (or Dick Smith in Australia) and pay $10-20 for something that would cost 50 cents to purchase in China? As The Onion has observed we do not need so many cables any more and Radio Shack has become irrelevant. These days it survives by selling mobile phone contracts.
Well as my little SD card survey demonstrates the big-box electronics stores here have become Radioshack – albeit with a bigger footprint and the pretence of "lowest prices". But Radioshack didn't blow up, it just sort of drifted away. The stock was $70 in 2000 – the peak year in which everyone was connecting their computers to the net and needed all those cables. It is $9 now.
That I think is the future here too. The two stores won't deal either one a death blow. Gerry Harvey will continue to lose share to JB Hi-Fi (who look cheaper and cooler) but he and his company are rich and they can bleed for a very long time. JB Hi-Fi will continue to charge "convenience prices" to the customers hiding behind their faux-cheap facade.
And we will wake up in a decade and realise these companies are just not important – or for that matter even relevant.
John Hempton is chief investment officer of Bronte Capital Management, and blogs at Bronte Capital. Reproduced with permission.
Disclosure: no position in the funds. For various tax reasons we have elected to have no Australian positions.