Tuning in to JB Hi-Fi

JB Hi-Fi (JBH) has had an impressive history since its listing on the ASX in October 2003 with 26 outlets, at an institutional placement price of $1.80.

The share price subsequently rose to $23.71 in November of 2009 before dropping to $7.83 in June 2012. At the market’s close on Tuesday, the company was trading back at $20.84, representing a forecast price to earnings ratio of around 16 times forward earnings.

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JBH now operates 177 consumer electronics stores, predominantly in high-traffic locations and is considered to be the leading consumer electronics retail chain in Australia and New Zealand. The company has achieved strong earnings growth over the past decade through store rollouts, innovative product offering and marketing success.

JBH is heavily exposed to trends and developments in new technology and electronic devices, which means that the company has to regularly refresh its product offering. This in itself creates an opportunity for growth by becoming the destination of choice for consumers to purchase or upgrade to the latest electronic product.

JBH operates on a low-cost model and positions itself in the marketplace as a discount retailer with a focus on value and low prices for the customer. It is on track to reach its goal of 214 stores in high-traffic locations within the next few years.

The company has managed to navigate through the tough consumer environment and strong price-deflationary conditions over the past several years. There are encouraging signs that the retail environment is improving and price deflation has stabilised. This has been helped by more rational industry conditions including the change in ownership of Dick Smith Electronics and the demise of several competing electronics chains.

There is a perception that JBH is possibly close to the end of its growth life cycle. I believe this is unfounded, and JBH has articulated to the market several organic growth initiatives combined with the possibility of acquisitions.

The recent 2013 results showed a marked improvement in the financial results. During the second half of the financial year, total sales grew at 10.3% and like-for-like sales grew at 3.2%. The company also experienced gross margin improvement over the year with, earnings before interest and tax (EBIT) margin expanding from 5.2% to 5.4%. Balance sheet debt finished the period at $57 million, down from $110 million. I expect JBH to have a debt-free balance sheet within 12 to 24 months, assuming no acquisitions.

Financial year 2014 trading outlook

The company expects sales to increase by 6% to 8% on the prior year and to open 12 new stores through the year. At the recent AGM, JBH stated that its sales for the first quarter had increased by 8.1% and like-for-like sales had increased by 2.9%.

One of the key headwinds the company has faced in recent years has been the high Australian dollar. The high dollar has been a contributor to significant price deflation in the electronic goods category, combined with the propensity for consumers to shop offshore via the internet. I anticipate that a lower $A will slow the rate of price deflation and encourage consumers to shop within Australia, either online or within a bricks and mortar outlet.

There are several growth options which JB Hi-Fi has articulated to the market:

• New Stores – JBH has a target of 214 branded stores compared to 177 stores currently. Assuming 12 stores are opened each year, this gives three years left of store roll-outs.
• Acquisitions – I expect JBH to make an acquisition(s) to complement its current offering and to enable continuation of the store roll-out opportunity under a different brand.
• HOME concept – integrating home appliance categories within the existing JBH model. This will require existing JBH stores being converted to the HOME concept, and the company anticipates the potential for 50 HOME stores across Australia. Approximately 10 stores will be converted per year. JBH anticipates this will add $5 million in sales per store after the second year of conversion.
• Online – Online sales currently represent 2% of company sales, however they are growing at approximately 30% per year. The new JB Hi-Fi website will be launched this financial year. JBH also offers an online music streaming service and eBook downloads.
• JB Hi-Fi Commercial – the company sees this as a $500 million sales opportunity. This division will provide products and services to Enterprise and Education clients, for example IT support services to schools and corporates.

I am cautiously optimistic on the critical Christmas trading period for JBH. The month of December contributes approximately 25% of JBH’s annual profits. There are signs that consumer confidence and retail spending have improved recently and this should be reflected in the trading results for JBH. The Australian National Retailers Association was expecting overall retail sales for Australia to be 5.6% higher than last year for the Christmas period.

I look for stocks that have the potential for good earnings growth and potential for valuation expansion to then generate a multiplier effect on the stock price.

The current forward P/E ratio for JBH of 16 times earnings is undemanding relative to its historic P/E and compared to peer-group discretionary retail stocks. If JBH can demonstrate to the market over the next several reporting periods that its growth story is still in-tact, I believe there is potential for the P/E to expand.

Simon Bonouvrie is portfolio manager at Cadence Capital.