Vindication for JB Hi-Fi

JB Hi-Fi chief executive Richard Uechtritz made it clear in his presentation today that the broadly defined appliance retailing business in Australia is being concentrated among three players – JB Hi-Fi, Harvey Norman and the Good Guys chain. The giants Woolworths and Myer missed out.

That concentration is part of the reason why the Clive Peeters group is now struggling and it will affect other players.

The latest JB Hi-Fi result takes the company on to a new level. It is not the rise in sales and profits that is important, but rather the lowering of balance sheet risk. Harvey Norman chief Gerry Harvey has seen countless appliance retailers collapse because they took too much balance sheet risk, so Harvey Norman owns most of its stores and is structured partly as a property owning company.

Richard Uechtritz took a gamble on his business model and so the JB Hi-Fi financial model was very similar to structures that have failed. A huge slab of JB Hi-Fi equity capital was accounted for as intangibles. If you deduct the intangibles, past borrowings were several times shareholders' funds, plus the group had a huge lease obligation and a big staff who carried latent retrenchment costs if anything went wrong. Clive Peeters has a different business model to JB Hi-Fi, but its balance sheet looks a little like the JB Hi-Fi of old.

Richard Uechtritz's basic business model worked brilliantly, so his gamble paid off. Uechtritz sited his stores in shopping centres that had a large customer traffic and this minimised his marketing costs. He enticed customers through the door with games and gadgets and then had his big appliances at the back. He adopted the everyday low prices approach. As JB Hi-Fi got bigger, so its buying power increased and its marketing became more effective. By the time the 2008-09 slump arrived, JB Hi-Fi had achieved critical mass and it passed the stress-test brilliantly.

The June 30 2009 JB Hi-Fi balance sheet looks a lot more solid as cash pulses through the JB Hi-Fi veins.

Net equity capital after deducting intangibles jumps from $83 million to $148 million while net borrowings slump from $125 million to just $54 million. The trouble with so many appliance retailers is that they forget that when they borrow and lease they are double dipping on gearing. JB Hi-Fi lease payments in the year jumped from $38 million to $48 million but given the fall in borrowings and rise in equity capital that makes the group look much more secure.

And JB Hi-Fi is heading towards the Woolworths structure where amounts owing to suppliers approximate the level of stock, which makes the basic business self funding. JB Hi-Fi may never reach the Woolworths level because it has a slower stock turn, but it is headed in the right direction.

A year ago JB Hi-Fi had stock of $272 million and the net amount it owed its suppliers (after deducting rebates) was $145 million – a difference of $127 million.

At June 30 2009 JB Hi-Fi had stock of $325 million and owed its suppliers (after deducting rebates) $203 million – a difference of $122 million. While the difference is almost the same, sales jumped 27 per cent during the year.

JB Hi-Fi earned 88 cents a share for the 2008-09 year and is clearly set to exceed $1 a share in the current year. New risk will come when it achieves close to full store penetration and looks for a new model to invest its cash. That's what happened to Harvey Norman who picked Eastern Europe and Ireland as places to invest. Maybe Uechtritz will learn from Gerry Harvey.