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Mid-Cap

Harvey Norman - Is it still a wait and watch approach for this consumer facing stock?

September 16, 2015 | Team Kalkine
Harvey Norman - Is it still a wait and watch approach for this consumer facing stock?

The booming property market in Australia has provided a solid boost for Harvey Norman (HVN) in the 12 months ended 30 June 2015, with the retailer and property group reporting a strong growth in profit for the period. The company generates most of its earnings from selling household electronics and furniture, which have both sold well in the current property scenario. Group Chairman, Gerry Harvey, expects this trend to continue over the next few years and should support Harvey Norman’s growth in the medium term. He said that the outlook for property market in Australia continues to be positive particularly in respect of new starts and expenses on renovation. Indeed, this could certainly be a strong possibility if the Reserve Bank of Australia cuts interest rates again before the end of the year as experts are increasingly beginning to expect. In particular, more than one third of Harvey Norman’s stores are located in New South Wales where the property market has been particularly strong in recent years.


Result Overview (Source: Company Reports)
 

Results for the year ended 30 June 2015

Among the highlights of the results were a 25.6% growth in net profit before tax to $ 378.1 million and a growth of 26.6% in net profit after tax to $ 268.1 million. Global sales were up 4.6% to $ 6.02 billion and the strength of the balance sheet was demonstrated by $ 2.2 billion in property assets and the conservative gearing ratio with debt to equity at 19.88%. The results included an increase in the net property revaluation of $ 20.38 million compared to a decrease of $ 11.65 million in the previous year. Excluding these property revaluation adjustments, the net profit after tax increased by 18.1% to $ 261.84 million compared to $ 220.10 million in the previous year.


 
Chairman Harvey said the results demonstrated the strength of the integrated retail, franchising property and digital systems in a challenging retail environment. The fourth quarter marked the 10th consecutive quarter of quarter on quarter increases in Australian franchise sales, and continuing investment in the Omni channel strategy to deliver seamless and high quality customer experience is paying off. Headline franchise sales revenues grew by 3.7% to $ 4.95 billion and like-for-like franchise sales revenues grew by 4.5% to $ 4.92 billion. The strong growth in franchise sales has also enabled the company to cut back on tactical support to franchises by 20% in each of the past two years.
 
The retail segment which is operated by the company reported an increase in net profit before tax of 42.9% to $ 41.03 million and operations in New Zealand outperformed in a particularly competitive market and sustained efforts to boost brand recognition resulted in a reduction in trading losses in Ireland and Northern Ireland. This was partly offset by the operations in Asia where profitability was affected by lower gross margins and higher costs because of new store openings.
 
The balance sheet continues to be strong and net assets increased by 2.6% to $ 2.56 billion from $ 2.49 billion in the previous year. Net debt to equity ratio fell from 22.4% to 19.88% reflecting the robust cash generation and the conservative capital management. Real property assets increased from $ 2.29 billion in the previous year to $ 2.32 billion. Prospects for the real estate market in Australia remain positive particularly in the case of new starts, expenses on renovation and clearance in the secondary market. The market leading position in the homemaker category enables the company in a position to continue to capture market share and deliver strong growth. In the period, 1 July 2015 to 27 August 2015, franchise sales are up by 5.5% on a headline basis and 6.6% on a like-for-like basis and the outlook remains positive. The Board of the company has recommended the payment of a fully franked dividend of $ .11 per share.


Sales Growth and Company Operated Stores (Source: Company Reports)
 
There were a number of factors which had an impact on net profit before tax. There was a 39.6% jump in the profitability of the franchising operations to $ 200.36 million because of an increase of 7.2% in franchise fees and a decrease of 21.2% amounting to $ 21.84 million in the level of tactical support provided to franchisees. There was the impact of the $ 20.36 million turnaround on net property revaluation to an increase of $ 8.73 million from a decrease of $ 11.65 million in the previous year. There was a decrease of 40.2% or $ 8.9 million in the trading losses of the operations in Ireland and Northern Ireland. There was a 3.2% increase amounting to $ 9.26 million in rents received from franchisees and third-party tenants, and a 6.7% increase in the profitability of the company owned stores in New Zealand.
 

Strategy

The Omni channel strategy provides a seamless experience across different platforms such as physical stores and digital interfaces creating an integrated retail network. Distinctions between various platforms such as online or social are becoming increasingly unimportant and customer needs can be met through geographically distributed fulfilment. Big data can produce valuable information about preferences and processes relating to customers and the catalyst for the new services is the slogan "click and collect".


Franchisee Sales Revenue (Source: Company Reports)
 
In the area of efficiency improvement, the deployment of different modules of the systems for franchisees is on time and within budget as is the implementation of real-time analytics. In the field of workforce productivity, good progress has been made with 120 franchised complexes going live ahead of the 36 franchises originally scheduled.
 

New acquisition

The company has announced that through a wholly-owned subsidiary, it has acquired a significant stake of 49.9% in the privately owned farming company Coomboona Holdings. The company has agreed to pay around $ 25 million for the stake and will advance a further $ 9 million to the company which owns land and farm assets in the Coomboona Valley in northern Victoria. Though the payment is relatively small, we're puzzled by why a well-managed retailer should invest in the agribusiness sector. Future developments will be interesting to watch. The decision to buy a stake in land and farming assets appears to be linked to a relatively small expense but the merits are yet to be witnessed. However, the stock still has a trading momentum given the core business.


HVN Daily Chart (Source: Thomson Reuters)
 
Accordingly, we think that the stock is Expensive at the current price of $3.990.

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