There’s no escaping it: our negative call on JB Hi-Fi has been simply wrong*. The stock hit an all-time high above $30.00 yesterday after the release of a better-than-expected 2016 result. It’s currently up 46% since our Avoid recommendation in JB Hi-Fi: Result 2015 and 149% since our even more embarrassing Sell in JB Hi-Fi: Steep descent ahead.
Sales in 2016 rose 8% to $3,955m. The collapse of competitor Dick Smith during the year helped, as did the government’s small business tax incentives. The company seems to be managing the transition away from music, movies and games software well; sales in the category have fallen from 23% of total sales to 14% over the past five years. On a same-store sales basis in Australia, the 5.5% total sales increase during the year swamped the 7.6% decline in the increasingly less significant music, movies and games software category.
The sales growth translated into decent earnings growth, with net profit rising 12% to $152m. The 21.9% gross margin has been a lot more resilient than we expected in JB Hi-Fi: Steep descent ahead, while costs remain very low. In 2016 JB Hi-Fi’s cost of doing business was 15.2%, a ratio that remains the envy of many retailers.
Strong 2016 final result
Benefited from Dick Smith collapse
We've overestimated competition
We’ve been sceptical about the other side of JB Hi-Fi’s transition – the decision to enter the appliance market. Of the company’s 194 stores in Australia and New Zealand, 59 of them are now branded JB Hi-Fi Home and include a full range of small and large appliances. The company expects a sales uplift of $5m from each JB Hi-Fi Home store on maturity but it’s early days and only a handful are meeting the target so far.
JB Hi-Fi’s total sales of appliances remains small; we estimate less than $200m. However it could catapult itself into the big league if it buys appliance retailer The Good Guys, which is up for sale. We’ll say more if the acquisition is announced, although be aware it will require a capital raising. Management is obviously interested but says it will only pursue The Good Guys if it makes ‘compelling financial sense’.
We’ve long acknowledged that JB Hi-Fi is an impressive retailer. It now dominates many categories in the consumer electronics market, including computers and large screen televisions. Management’s marketing skills were evident in the recent July promotion: same-store sales growth was 9.5%, with strong growth from televisions. Presumably the Olympics helped, but JB Hi-Fi works with its suppliers to take full advantage of opportunities like these.
With a residual sales boost from Dick Smith’s closure likely to continue into the first half, JB Hi-Fi is forecasting sales of $4.25bn for the 2017 financial year. It’s probably a conservative number and we’re expecting 2017 earnings per share close to 170 cents, which places the stock on a prospective price-earnings ratio of 17. It’s certainly not cheap but the company keeps defying expectations.
Our long-held negative view on JB Hi-Fi has been no reflection on the business itself or its excellent management. Rather it reflects the history of consumer electronics and appliance retailers around the world. Dick Smith is only the latest casualty of a notoriously competitive and difficult industry.
|Year to 30 Jun||2016||2015|| /(–)
|Same-store sales growth (%)||5.4||2.9||N/a|
|Gross margin (%)||21.9||21.9||N/a|
|Cost of doing business (%)||15.2||15.3||N/a|
|* 37 cent final dividend, 100% franked, ex date 25 Aug|
Internationally, Best Buy, the largest US consumer electronics retailer, has seen sales decline 9% since 2012 as Amazon and other competitors nibble away. Eventually JB Hi-Fi may face similar competition, whether from Kogan.com, Amazon or someone else. Presumably Kogan’s long-term aim is to take share from JB Hi-Fi, and it can and will undercut the market leader on price (see Table 2 from Is Kogan on sale?).
New competitors are certainly coming but the threat looks more distant. Kogan might be growing fast but sales are only $200m, less than 5% of JB Hi-Fi’s. And despite the posturing, there are few signs that Amazon will enter the Australian consumer electronics market any time soon.
In the meantime, JB Hi-Fi can enjoy its time in the sun. We belatedly acknowledge that the sun might shine for a while yet.
Make no mistake – this about-face does not imply a positive view. You don’t need to own JB Hi-Fi shares, particularly at a time when the company is benefiting from several one-off factors. Sales growth will slow over the course of 2017, as management itself has highlighted. The entry into the appliance market could yet prove to be the company’s undoing.
Our new price guide range is wide, reflecting the range of possible outcomes. But we have to acknowledge this impressive retailer continues to thrive in a difficult industry. We’ll keep a watchful eye out for new competition, and recommend keeping any holdings below 4% given the risks. That said, we’re belatedly moving to HOLD.
* We recommended the stock back in 2005 at $3.43. Had you followed our recommendations to the letter, you would have fully sold the remaining half of your holding at $11.75 in 2012.