JB Hi-Fi Limited (ASX:JBH) has become a major retail company in Australia, operating a total of 123 stores, with 109 in Australia and 14 in New Zealand. The group aims to have 210 JB Hi-Fi branded stores in the long term, with 18 new stores expected to open in FY10. JBH pursues an everyday low price strategy (EDLP) i.e. offering lower prices than competitors. This strategy is reflected in gross margins of circa 22% over the past five years. This is lower than gross margins of 26% for Clive Peters and Harvey Norman. As seen in recent results, JBH can grow turnover by increasing marketing and/or expanding the number of stores. The business has pursued both options. Sales and marketing expense increased by 19% to $230.4 million in FY09 with comparable store sales growth of 11.5%. 19 new stores were opened during FY09 with total sales revenue increasing by 27.2% to $2,327.3 million. Average sales per store have improved from $15 million in FY03 to $19 million in FY09. Consumer electronics is JBH's largest product category which includes televisions, Hi-fi, DVD players, home theatres and digital cameras. This category focuses on high growth products such as DVD players, digital cameras, wide screen and plasma televisions and home theatre systems. Their entire product range consists of: Source: GSJBW research estimates Below are estimated gross margins for each product category: Source: GSJBW research estimates
Estimated gross margins for consumer electronics can be broken down as follows: Source: GSJBW research estimates The introduction of games and computers (lower margin products) in FY05 and the increasing proportion of sales made up by this category have seen a gradual decline in gross margins. JBH generates the majority of its sales revenue from the retailing of consumer electronics. Mobile phones, speakers and accessories, CD and DVD’s and car sound systems are where it earns the greatest profit margins. SWOT Analysis (Strength, Weaknesses, Opportunities and Threats) Strengths • JBH has a well recognised brand name and clear position as a low price retailer. • The business is able to maintain low product prices through its membership of the National Associated Retail Traders of Australia (NARTA). NARTA is the largest independent electrical buying group in Australasia. Membership allows JBH to enjoy significant economies of scale through bulk purchases. • JBH has a specialist product range, differentiating it from competitors. For example, it is a back catalogue retailer, stocking over 35,000 CD and 5,000 DVD earlier release titles. JBH allocates greater floor space to CD’s and DVD’s than its competitors to attract foot traffic and provide the opportunity to cross sell. • A focus on cost control led to the cost of doing business declining from 16.0% in FY07 to 15.3% in FY08 and further down to 14.5% in FY09. JBH does not own or operate distribution centres. All inventories are delivered directly to each store and remain on the shop floor. This removes a layer of operating costs and contributes to the low price strategy. • JBH has one of the lowest rent expenses in the industry - rent expense as a percentage of sales revenue has been consistently at 3%. JBH enjoys lower rent and more attractive sites inside shopping centres because of the high volume of foot traffic that its stores generate. • It is difficult for new entrants to compete due to JBH’s significant economies of scale, high working capital commitments and higher rents for a new entrant to secure prime retail sites. Weaknesses • A shift in the sales mix towards lower margin games and computer products has resulted in gradual declines in gross margins. • The Clive Anthony business is more affected by macro economic conditions than home entertainment products. This is due to the large ticket nature of Clive Anthony’s products, such as fridges and washing machines. • Consumer electronics faces a high risk of obsolescence as new models enter the market with increasing frequency. The risk is that JBH has to discount prices on outdated models, thus reducing margins. • New stores can take up to a year to mature and gain traction. This means that cash is tied up in inventory for a year before generating profits for investors. • The majority of JBH’s products are available through other retailers and formats e.g. internet downloads of music and movies. Hence, the product offering itself is not a source of competitive advantage. Opportunities • Innovation in consumer electronics will fuel demand for the latest products. If JBH offers these products, it will provide additional revenue streams. • When JBH enters into new product categories, e.g. games, computers and accessories, prices may be kept low to build market share. In theory, once market share has been established, prices can be increased providing a boost to gross margins. • As new stores mature and gain traction, sales revenue will increase and flow more directly through to profits. Threats • The biggest threat to JBH is, and comes from, a slow down in consumer spending. Not only could consumers reduce their discretionary spending, but competitors may cut prices to maintain or grow market share. Both factors will compress margins. However in the recent economic downturn JBH has managed to increase same store sales. • A danger faced by JBH is saturation of its market. The company operated 105 JB Hi-Fi stores at 30 June 2009 and expects to open 18 new stores during FY10; bringing the total number of stores to 123. Management estimates that the market can sustain 210 JB Hi-Fi stores. While 18 stores may not be opened given the current economic climate, it is possible for the 150 store saturation point to be reached within the next five years. It remains to be seen what management will do once this point is reached. • Any fall in the Australian dollar will increase the cost of imported goods and reduce margins. Although JBH doesn’t import stock directly, it buys imported goods from distributors. The intensity of competition between distributors means that the distributors will absorb some of the price increase, providing some support to margins for JBH. • Sourcing new sites will be increasingly difficult as JBH are already located in prime retail space and will compete with other retailers for space. • The trend towards internet downloading of music and movies could dampen sales of CD’s and DVD’s and gross margins as these are higher margin products. Historical financials Return on Equity (NPAT / Shareholders Equity) has strengthened over the past five years. This is an impressive result given the business’ growing equity base (which has itself grown faster than borrowings) as reflected in the increase in Equity Per Share. Investors should note that it will become more difficult for the business to continue to reinvest a large percentage of profits at these high rates of return. The recent result was particularly impressive. In a tough operating environment JBH continued to improve return on equity through both improving same store sales and through rolling out new stores. The company appears to be executing its business to near perfection at this time. Rent expense as a percentage of sales have been increasing as more new stores are opened in shopping centres. Low rent expense is a key to maintaining its EDLP strategy. Gearing (Net Debt to Equity) has been reduced over the last year and now stands at a manageable 23.4%. Forecast business performance Based on current forecasts, we have adopted an APC of 50% to reflect the difficulty JBH will face in maintaining the current high level of ROE. The equity base has risen substantially due to reinvestment and with the eventual threat of market saturation JBH will not be able to maintain the current high levels of ROE forever. The business is a leader in its class with a robust business model and a demonstrated track record. We see good value at current levels. Guy Carson uses StockVal. Exclusively for The Bull subscribers, StockVal is offering a free two-week test drive. Click here.
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