What the market is missing with JB Hi-Fi

On the surface, it appears JB Hi-Fi (ASX:JBH) is trading at a small discount to our estimated intrinsic value range. A deterioration in the outlook and the rate of that deterioration is something however that cannot be quantified and therefore is unlikely to be factored into comments by management. We simply don’t know how deep the housing slow-down is going to plunge and an ALP victory could render conditions materially worse. 

Buyers at these levels are probably less risk averse than your author who believes a deep discount to intrinsic value is required for JBH, given the generally mature nature of the business, and the weak macro, retail and housing picture. The deeper/worse economic scenarios would reduce our valuation further and therefore a bigger discount is required. 

The longer-term online threat - most Australian retailers haven’t invested nearly enough in their ecommerce channels - will return to influence sentiment too at some point within a medium-term investment horizon.

Three Key Takeaways

1. JB Hi-Fi’s first half result has beaten most expectations, achieving 5.5 per cent NPAT growth and NPAT of $160.1 million versus consensus at $153 million - despite having to comp strong prior numbers and doing so in a tough retail environment, remembering retail sales plunged in January as did foot traffic. The surprise was largely driven by the Good Guys, which beat most analyst expectations (Good Guys EBIT $44 million vs consensus at $38 million), but the acquisition of which I maintain marks the peak of Australia’s retail ‘Good Times’ more generally. The appliance retailer managed to recoup the gross margin compression it experienced in the previous half.
2. Unsurprisingly, the outlook is beginning to slow. January 2019 sales update reveals challenges are increasing. JB Hi-Fi Australia’s comp sales growth of 1.5 per cent is well below the prior corresponding period’s (Jan 18’s) 4.8 per cent. The Good Guys are just weak at 0.3 per cent. JB Hi-Fi Australia is now at the point where some of its operating leverage begins to work in reverse and The Good Guys should deteriorate further if macro and housing trends are maintained. Keep in mind Australian monthly new house sales have slumped to 2001 levels, it shouldn’t be surprising that retailers specialising in selling goods to fit out homes, are going to soon be doing it much tougher.
3. The company downgraded its FY19 sales guidance slightly for JB Hi-Fi Australia, which is now $4.73 billion versus $4.75 billion previously. The Good Guys sales guidance was maintained at $2.15 billion. Total Group sales are slightly softer at $7.1 billion versus $7.15 billion previously. FY19 NPAT is guided to grow by between 1.6 per cent and 5.1 per cent, which is a little better than market expectations but implies slowing in the second half. The company expects to open five new JB Hi-Fi Australia stores (in addition to closing two) and two new Good Guy stores. One New Zealand store is expected to close in FY19.

What the market is missing

This mornings’ circa three per cent share price rally perhaps reflects three things:

• Some misplaced optimism
• Short covering
• Low expectations going into the result

But these factors don’t lend themselves to a sustainable rally. With the company noting:

“We continue to see positive sales growth, however in the Christmas quarter and January we have seen increased volatility and a bias in customer purchasing towards key promotional periods.”

This suggests there will be some pressure on gross margins.

A 15 per cent rally in the share price from the recent lows may reflect short covering ahead of this result and immediately following. The difficulty, however, remains the outlook which includes a high level of household debt, little wage growth and perhaps peak employment. 

An ALP victory will put another nail in the coffin for home sales activity and therefore demand for JBH and TGG products. I don’t expect the short covering rally ahead of, and immediately following, this result to be followed by any ongoing optimism.

Negative sentiment will probably return and the downside risks currently appear to outweigh the possibility of positive catalysts.