Store Closure Program Helps Harvey Norman to Increase Profitability of Remaining Portfolio

Harvey Norman reported a 20% increase in fiscal 2014 net profit after tax, or NPAT, excluding net property revaluations of AUD 220.1 million, with revenue up 14% to AUD 1,513.6 million. International revenue was favourably lifted by a weakening Australian dollar while Australian revenue was up only 1.1%. We view this relatively weak sales performance, in a period of rapidly rising housing activity, as indicative of the structural headwinds Harvey Norman is facing as consumers increasingly go online to compare prices and as competitors, such as Bunnings and JB HiFi, increasingly diversify into offering similar branded products for the home. Our fair value estimate reflects a view that growth will materially diminish during the next five years as competition for revenue increases. After updating our financials for fiscal 2014 and accounting for the time value of money our fair value estimate increases to AUD 1.80 from AUD 1.70. This value is significantly below the current share price as we believe the market is underestimating the deleveraging of earnings which occurs as operating costs grow faster than revenue.