Company Reports

Fiscal 2024 was a year to forget for the Australian retailing sector, and no-moat Harvey Norman wasn’t exempt from the challenging marcoeconomic environment. In its largest overseas market, New Zealand, it was even worse. Consumers across the Tasman are hurting more, with elevated cost-of-living pressures compounded by even higher interest rates than in Australia and declining house prices reversing the wealth effect.

Harvey Norman predominantly sells commoditized branded electronics, such as televisions and computers, home appliances, and furniture. We expect the growth of the Australian consumer electronics market to lag overall consumer spending because of constant deflation driven by intense competition. Headwinds continue to mount as internet research and price comparisons threaten Harvey Norman's brick-and-mortar peers. In the core Australian market, Harvey Norman must compete on price with online offers, despite offering its customers in-store service and advice.

The upcoming August 2024 reporting season will draw the line under a difficult year for Australian retailers in which they navigated soft demand and soaring labor costs. The combination results in a profit margin crunch and declining earnings for many retailers.

Talk of interest rate cuts and impending tax cuts is sparking a rally in consumer cyclicals. We agree these factors improve the near-term outlook for consumer spending, with cyclical retailers more exposed. We expect the combined impact of fiscal and monetary tailwinds to underpin mid-single-digit growth in total retailing sales in the medium term—compared with our estimate of only 2% growth in fiscal 2024. But underlying our near-term forecast is a significant divergence across categories, with sales in cyclicals virtually flat and defensives up 4%.

Harvey Norman predominantly sells commoditized branded electronics, such as televisions and computers, home appliances, and furniture. We expect the growth of the Australian consumer electronics market to lag overall consumer spending because of constant deflation driven by intense competition. Headwinds continue to mount as internet research and price comparisons threaten Harvey Norman's brick-and-mortar peers. In the core Australian market, Harvey Norman must compete on price with online offers, despite offering its customers in-store service and advice.

No-moat Harvey Norman’s global system sales decline of 7% in the first half of fiscal 2024 is tracking our full-year estimate. First-half net profit after tax of AUD 214 million was down 29% versus the previous corresponding period. We maintain our earnings estimates and continue to forecast a rebound in sales and earnings from fiscal 2025, as global consumer demand strengthens, with lower interest rates coming to pass the critical factor. We estimate pretax margins recovering to long-term maintainable levels at around 16% by fiscal 2026 versus an estimated 13% in fiscal 2024. We increase our fair value estimate by 2% to AUD 4 due to the time value of money. The board declared a fully franked dividend of AUD 0.10 per share, down 23% on the PCP.

E-commerce platforms have been outperforming physical stores recently. Transaction data from National Australia Bank suggests online retail sales in October lifted 10% on last year, while total retail trade was up only 1%, as reported by the Australian Bureau of Statistics.

We maintain our fair value estimate on no-moat Harvey Norman at AUD 3.90 per share. Harvey Norman’s core Australian franchisees segment continues to experience weak demand for electronics and home appliances with demand normalizing postpandemic, exacerbated by cost-of-living pressures. Sales momentum has deteriorated slightly since July 2023. In the September quarter 2023, Australian franchisees' sales declined by 14% versus the previous corresponding period, worsening from a 12% decline in July 2023. Including sales from its overseas company-owned operations, global sales declined by 9% in the September quarter.

We expect only modest discretionary goods sales growth in fiscal 2024, while interest rates stay high and household incomes struggle to keep up with inflation. With demand soft, discounts and promotions abound in discretionary retail, and with wages rising as well, earnings are under pressure. But for some, cost pressures are easing. Steep declines in global food commodity prices bode well for fast-food restaurants. Quick service restaurant operator no-moat Collins Foods and master franchisee narrow-moat Domino’s Pizza screen as undervalued.

No-moat Harvey Norman’s fiscal 2023 underlying profit of AUD 680 million—before tax and excluding net property valuations—was marginally better than the AUD 670 million midpoint of the guidance range from late June 2023. Although global sales and operating profits in fiscal 2023 broadly met our expectations, soft trading in July 2023 drives our near-term earnings downgrade. Second-half fiscal 2023 sales declined 12% in the core Australian franchising operations versus the previous corresponding period. In July 2023, Australian franchisees saw weak demand for electronics and home appliances with demand normalising after the coronavirus pandemic, exacerbated by cost-of-living pressures. We reduce our fiscal 2024 EPS estimate by 6% to AUD 0.33 per share.

We maintain our AUD 3.90 fair value estimate for no-moat Harvey Norman following a weaker-than-expected fiscal 2023 first half to December 2022, and soft trading update for January 2023. We lower our fiscal 2023 earnings estimates by 10% to AUD 0.40, mainly due to a faster-than-expected decline in profit margins in the Australian franchisees and overseas retail segments. However, we still expect group profit margins—defined as profit before tax as a percentage of global sales—to stabilise at long-term maintainable levels of 7% from fiscal 2024.

No-moat Harvey Norman’s underlying EPS declined by 9% in fiscal 2022, but earnings receded less than the 29% decline we expected. We increase our fair value estimate by 5% to AUD 3.90 per share due to higher near-term earnings and the time value money impact on our DCF model. At current prices, shares screen as slightly overvalued.

Harvey Norman predominantly sells commoditised branded electronics, such as televisions and computers, home appliances, and furniture. Headwinds continue to mount as Internet research and price comparisons threaten the dominance of Harvey Norman and its brick-and-mortar peers. The domestic retailer must compete on price with online offers, despite potentially offering better and more expensive service and advice.

Harvey Norman predominately sells commoditised branded electronics, such as televisions and computers, appliances and furniture. Headwinds continue to mount, as Internet research and price comparisons threaten the dominance of Harvey Norman and its brick-and-mortar peers. The strengthening Australian dollar compounds the matter because now the lowest prices are invariably the large Internet retail suppliers based in the U.S. The domestic retailer is increasingly becoming the shop window for cheaper online channels. For this reason, we do not believe Harvey Norman to have a sustainable competitive advantage, leading to a no moat rating.

Harvey Norman has offered a 1 for 22 prorata renounceable entitlement offer at AUD 2.50 per share to raise AUD 120.7 million. The entitlement offer closes at 5.00pm on Monday, 15 December. With the current stock price trading well above the offer, we recommend holders take up their entitlement and then sell on market.

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.

Harvey Norman predominately sells commoditised branded electronics, such as televisions and computers, appliances and furniture. Headwinds continue to mount, as Internet research and price comparisons threaten the dominance of Harvey Norman and its brick-and-mortar peers. The strengthening Australian dollar compounds the matter because now the lowest prices are invariably the large Internet retail suppliers based in the U.S. The domestic retailer is increasingly becoming the shop window for cheaper online channels. For this reason, we do not believe Harvey Norman to have a sustainable competitive advantage, leading to a no moat rating.

Harvey Norman increased like-for-like sales from its core Australian operations by 3.6% for the three months ended 31 March. We expect growth to slow in the fourth quarter of fiscal 2014, reflecting recent declines in consumer confidence. We make no change to our fair value estimate of AUD 1.70. This is well below the market price so we view the shares as materially overvalued. We differ from the market because we expect sales data to remain weak while operating costs increase at a faster rate and dilute future returns. Over the longer term we expect competition for branded products will increase as consumers are drawn to value and the convenience of shopping online. We also expect the larger retailers such as Wesfarmers and Woolworths will move into selling a range of electrical and household goods through their hardware branded stores. We expect price to become an increasingly key differentiator in determining where consumers transact. Those retail companies which can deliver goods to the consumer at the lowest cost, either through a low-cost online business or through cost advantage achieved through scale, will take market share over time.

Harvey Norman predominately sells commoditised branded electronics, such as televisions and computers, appliances and furniture. Headwinds continue to mount, as Internet research and price comparisons threaten the dominance of Harvey Norman and its brick-and-mortar peers. The strengthening Australian dollar compounds the matter because now the lowest prices are invariably the large Internet retail suppliers based in the U.S. The domestic retailer is increasingly becoming the shop window for cheaper online channels. For this reason, we do not believe Harvey Norman to have a sustainable competitive advantage, leading to a no moat rating.

Harvey Norman reported a first-half fiscal 2014 increase in group revenue up 3.6% to AUD 2.99 billion, with net profit after tax, or NPAT, excluding net property revaluations up 3.6% to AUD 117.4 million. International revenue benefited from a weakening Australian dollar, while underlying Australian revenue gained just 1.4%. We view this relatively weak sales performance, in a period of rapidly rising housing activity, as symptomatic of the structural headwinds facing Harvey Norman, as price-sensitive consumers increasingly go bargain-hunting online at competitors such as Bunnings and JB HiFi. Our fair value estimate reflects our view that returns will materially diminish over the next five years as competition for revenue builds. We make no change to our fair value estimate of AUD 1.70, or our high fair value uncertainty rating. We believe persistent weakness in revenue contributions will be the catalyst for the market to converge the share price in the direction of our fair value estimate.