On 8th June 2011 the Retail Forecasts report was released, prepared by independent economic forecaster Deloitte Access Economics.
The experts at Deloitte expect inflation-adjusted growth in retail sales for the current fiscal year will come in at 1.3% – the worst performance in 20 years. However, in 2011/2012, they expect growth of 2.2% followed by 3.3% growth in 2012/2013.
To those who read last week’s sector scan column on the TheBull, this should come as no surprise. In that column, general manager of Zodiac Securities Steven Hing told us that investors with an optimistic view of the future of consumer discretionary spending could find value in the beaten down share prices of solid companies in this sector.
He gave us a list of five, highlighting JB Hi-Fi (JBH) as a “well-managed company with good long-term fundamentals.” So let us take a look at JBH, by the numbers.
Most retail investors are well aware that numbers in isolation without some comparative indicators are not necessarily useful. However, some fail to appreciate the challenge of finding a meaningful comparison.
The standard measure is the average value for the business sector as a whole. In our case, that is consumer discretionary. However, an average is, well, just an average – a muddled middle if you will. High performance numbers are washed away by the low performing values.
The more meaningful approach is to select a direct competitor for comparison and use the sector to spot “outliers” – numbers significantly higher or lower than the sector average. For us, the reality is JBH has few “apples to apples” competitors on the ASX, so finding an appropriate comparator will take a little creativity.
JBH is a discount retailer, specialising in a variety of consumer personal electronics, with a customer base that slants towards the young. Based on product, one might be tempted to use retailer Harvey Norman (HVN) as a comparator. However, HVN is a franchiser, so we think a better comparator is outdoor-oriented retailer Kathmandu Holdings (KDH), which is also on Hing’s list. Both own their own stores and both are expanding and attract similar customers.
To validate your selection of a comparator, it is a good practice to compare share price performance. Here is a one-year price chart comparison for JBH and KMD.
Two shares that are comparable in some way should reflect similar, but not identical, price movements. We know consumer discretionary spending in the past year has been less than stellar, so two competitive companies usually trend in the same direction. Up until the middle of March, these two did just that.
For our second comparator to JBH we are going outside the box to select a company that also deals in consumer electronics, but rents instead of sells. The company is Thorn Group (TGA). Here we would expect the share price to move in opposite directions. In theory, if people are reluctant to buy a personal computer, they might be more willing to rent. Here is the chart.
The picture says it all. Although there are no guarantees anywhere in life, we at least have a general indication we have chosen valid comparators. Now let’s look at some numbers.
Profitability Ratios/Dividend Yields
Return on Equity (ROE) tells us how a company utilises investor dollars to generate earnings growth, with ROEs between 15% and 20% indicating good performance.
Return on Assets (ROA) tells us how well the company uses its assets to generate earnings growth, and dividend yield shows how much the company pays out in dividends for the reporting period relative to its share price.
|ROE (Return on Equity)||41.0||13.76||24.93|
|ROA (Return on Assets)||12.86||10.0||14.43|
While KMD is clearly the trailer here, the numbers for all three companies show how businesses can remain profitable even during economic downturns. Despite weaker than expected consumer discretionary spending, all three companies managed to maintain a dividend and shareholders of JBH saw an impressive ROE performance. That number is an “outlier” and we will want to investigate further when we go behind the numbers.
Liquidity and Debt Ratios
The two liquidity ratios – current and quick – measure the ability of a company to come up with ready cash during the current fiscal year. Ratios of 2 or more are considered safe and anything under 1.0 are a cause for concern. However, as always, the nature of the business in which the company operates makes a difference.
At first glance, JBH’s quick ratio of .32 looks troublesome, but compared to the sector average it appears to be less worrisome.
|Debt to Equity||9.85||34.25||37.89||N/A|
Debt to equity shows how much the company borrows to operate as opposed to financing its operations completely from shareholder equity, which is rarely advisable. JBH appears to shine here, but this number requires some perspective.
Debt is often relative to the company’s business model, especially regards inventory. JBH is a high volume discount retailer while KMD sells higher-end products one would expect to remain on the shelves for a longer period.
If we are right about that, one would expect to see a better inventory turnover ratio for JBH since their business model moves product out the front door faster. If you do the math from the financial statements you will find that inventory turnover for JBH is 5.9 while only 2 for KMD. TGA rents so the ratio does not apply.
With that in mind, KMD’s debt level looks more reasonable. JBH “turns” its inventory about 6 times a year so they have less need to borrow to buy inventory. KMD only turns its inventory twice a year.
Market Valuation Ratios
None of these valuation ratios indicates any of these shares are overpriced from a value investing perspective. The PEG ratio tells us all three actually may be a bit undervalued, especially KMD. The outlier here is the P/S ratio for KMD. If you have an interest in KMD, that number bears further investigation in the company’s financial statements.
|Price to Earnings (P/E)||13.52||20.71||10.87||12.14|
|Price to Earnings Growth (PEG)||.85||.04||.55||1.19|
|Price to Book (P/B)||6.10||1.74||2.85||2.23|
|Price to Sales (P/S)||1.19||23.39||1.61||1.19|
Year over Year (YOY) Performance
Steven Hing told us JBH has a long history of solid performance, so let us see if we can validate that. Here are some numbers for the last five year that tell the tale:
|Net Profit after Taxes (NPAT)||25.8$m||40.4$m||65.1$m||94.4$m||118.7$m||+25.6|
|Earnings per Share (EPS)||25cps||38cps||61.8cps||88.3cps||109.7cps||+24.3|
On every category, JBH has grown each year, even in the period immediately following the Great Financial Crisis (GFC). Note that the %Change column represents the change between fiscal year 2009 and 2010. Steven Hing was certainly right about long-term performance.
But what about future performance? Let’s look behind the numbers to see what we can learn.
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