Harvey Norman

Harvey Norman reported its third quarter sales yesterday. There was little improvement from the second quarter, which was itself a dire result (see 1 Mar 12 (Hold – $2.07)).

Global same-store sales fell 7.5% in the third quarter (compared with an 8% decline in the second quarter). In Australia, the respective figure was -7.7% (second quarter: -9.5%). These declines remain considerably worse than JB Hi-Fi, which reported a profit downgrade last week.

While Harvey Norman has been discounting to maintain market share, it’s not working yet. Rather, everyone is suffering the pain of lower gross margins. While Harvey Norman will be able to outlast all other competitors—thanks to its ability to use its property portfolio as security for additional debt—it’s a damaging strategy. WOW Light and Sound and Sleep City, both of which fell into administration recently, won’t be the last casualties.

Management noted that the same weak trends had continued into April. Still, the current quarter might show some improvement due to seasonal factors (furniture is traditionally stronger this quarter), the recent interest rate cut, and the impending London Olympics.

The company also provided a profit update, which on our rough estimates implies underlying net profit for 2012 of $160m-$170m (earnings per share of 15-16 cents). Based on the mid-point of 15.5 cents, the stock is trading on a 2012 prospective PER of 13.

Whether these are artificially depressed earnings is difficult to tell, but there are structural issues as well as cyclical ones at work here. The stock is almost unchanged since 1 Mar 12 and we reiterate that the only thing keeping us in the stock is the property portfolio. Even here there are concerns, however, so expect a further analysis over the coming weeks. For now, HOLD.