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Morningstar | JB Hi-Fi Weathers Cyclical Storm and Takes Market Share. FVE Unchanged at AUD 24.50.

No-moat-rated JB Hi-Fi successfully navigated a tough retail environment in the first half of fiscal 2019, but we see cyclical headwinds persisting for the remainder of the fiscal year. We expect investor spending to be dampened by relatively sluggish wage growth, a weakening housing market, and uncertainty around the upcoming Australian federal elections in May 2019. Long term, we continue to expect JB Hi-Fi to defend its market share against new online competitors, with smaller competing store-networks acting as share donors to the group as well as Amazon & friends. We maintain our AUD 24.50 fair value estimate, with marginally lower forecast sales offset by the time value of money impact.

JB Hi-Fi’s 4.2% headline sales growth was below our prior full-year estimate of 5.8%. Nevertheless, total sales growth of 4.1% in Australia easily outperformed growth in the addressable market which was virtually flat over the period. JB Hi-Fi continued to act as a consolidator in the brick-and-mortar channel. However, the group is still underindexed in the online channel, with only 6% of Australian sales sold online, versus the current online penetration of 9% of total Australian retailing, and high-teens in the consumer electronics and home appliances market.

The group achieved positive comparable sales growth in all three segments, but growth slowed in January 2019. JB Hi-Fi Australia and The Good Guys generated 96.8% of group sales and 99.6% of EBIT in the first half of fiscal 2019. The small JB Hi-Fi New Zealand segment displayed the strongest like-for-like growth at 12.6% and returned a profit in the half, although it was an immaterial contributor to the group’s results. Online sales grew by 21% in the first half of fiscal 2019 and we calculate it accounted for about a third of JB Hi-Fi Australia’s like-for-like sales growth. We forecast group sales in e-commerce to continue outperforming JB Hi-Fi’s brick-and-mortar channel over the next decade.

Hence, we see little potential to materially expand the group’s footprint beyond the current 316 stores.

Fading consumer sentiment is not the only headache for Australian retailers. A more long-lasting and structural challenge is the migration of consumers to the online channel. This brings with it additional capital spending and operating costs to develop, maintain and run an online channel, but also opens the door the a raft of new competitors--the online pure players. The product categories JB Hi-Fi deals in, namely consumer electronics and home appliances, are amenable to e-commerce and we anticipate the heightened competitive intensity introduced by online retailers to stay. In retailing commoditised products with price as a key differentiator, we expect EBIT margin expansion is unlikely.

There is further downside risk to our EBIT margin forecast. JB Hi-Fi’s offering to consumers could lack meaningful differentiation beyond the lowest price, and competitors such as Amazon Australia could seek to aggressively cut prices.

On the upside sales growth could be greater than our estimate of 3.7% annually over the next decade. Revenue could be bolstered were competitive intensity to abate, consumer demand for JB Hi-Fi’s products strengthen, or the company to take a larger slice of the online market without cannibalising sales from its physical store network. Also, JB Hi-Fi could further improve The Good Guys’ operations it acquired in November 2016, for instance, by expanding and diversifying its ranging to higher-margin products. In the first half of fiscal 2019, JB Hi-Fi’s group EBIT margins were essentially flat, up a mere 4 basis points on headline sales growth of 4.2%. We estimate full-year EBIT margins to increase 10 basis points to 5.2% in fiscal 2019.

Management provided fiscal 2019 guidance of underlying NPAT of AUD 237-245 million, versus our revised estimate of AUD 248 million, which we’ve lowered by 2%. Headline sales guidance of AUD 7.1 billion for fiscal 2019 was reiterated, and we lowered our sales estimate by 2% to converge.