JB HiFi: Is NOW the time to buy?

JB HiFi Limited’s (ASX: JBH) share price has been pummelled over the last year and is down 40% since 29th March 2011, and currently trading at $11.06.

As my Motley Fool colleague Bruce Jackson mentioned in this article, “You don’t make money looking backwards. Yet so many people do exactly that. They look at the recent past, and extrapolate that deep into the future.”

Recent financials

At its recent 6 month result to December 2011, JBH announced a fall in profits by 9.4% compared to the previous corresponding period, despite a rise in sales by 5.5%. Margins are being pressured, and if not for the recent share buyback, earnings per share (EPS) would have fallen by 9.4%. As it was, EPS rose marginally from 80.6 cents to 80.7 cents per share.

Debt reduced

JB HiFi is conscious of its debt, and in the last six months has reduced debt from over $200m to just $44m. With prodigious cash flows, this is likely to be gone within the next 6 months. Its current debt/equity ratio is just 21%.

Competitors

Its supposedly biggest competitors have fallen by the wayside, and competitors continue to fall by the wayside. Recent times have seen the collapse of WOW Audio and Visual Superstores in February (15 stores), and the recent collapse of Game (headquartered in the UK), which has 95 stores around Australia.

  • Brazin’s Sanity, Virgin and HMV brands; Strathfield Group; Tandy; EzyDVD; Retravision; Betta Electrical; Chandlers; Megamart and Clive Peeters have either disappeared, or only exist as shadows of their former selves.
  • Brazin got taken over by MCCH Pty Ltd (subsidiary of BB Retail Capital Limited) in Jan 2007 for $1.81 per share.
  • Sanity now operate 150 stores nationally, down from 215 (plus 32 HMV stores (HMV was taken over by Sanity, and 72 Virgin stores) in October 2005. Sanity also operates the Bandit.fm site, a digital music store.
  • Strathfield Group Limited (ASX: SRA) had 93 stores in 2007, its now under administration.
  • EzyDVD had 63 stores in 2003 – Now it has just 3, 1 in each of TAS, QLD and SA. It went into receivership in Dec 2008. EzyDVD was bought out by Franchise Entertainment Group, which also runs VideoEzy and Blockbuster.
  • Betta Electrical had 229 stores in 2003, now it appears to have significantly less.
  • The Good Guys has 97 stores across Australia currently.
  • Myer Holdings Limited (ASX: MYR) is rationalising its consumer electronics – ceasing to sell game consoles and games, and more than likely will cut some of its other product lines.

All of the above is good news for JB HiFi. The company has survived, and I think it will continue to survive.

Risks to JB HiFi 9 years ago

Back in 2003, the biggest threat identified to JB HiFI was illegal downloading of Music. Another risk at the time was supposedly “weak consumer sentiment” due to very high petrol prices. There will always be risks to any type of business, whether real or imagined. Many will not have the impact first feared.

Games

JB HiFi competes against many retailers selling games, and the biggest threat to them all is games being delivered online.

One bricks and mortar competitor, EB Games apparently has a higher cost model, which is helped by sale of pre-owned games, acquired through trade in specials. According to the JB HiFi website, JB HiFi doesn’t currently offer trade-ins on games, but will be offering this particular service in future. Look out EB Games, your offering is under serious threat.

Changing product lines

JB HiFi also used to sell car stereos and accessories. Some years before it listed, JB HiFi was solely in the business of selling high end stereo systems. It moved into music CDs, Movie DVDs, TVs and associated products prior to being listed.

The company has now moved into musical instruments, selling at this stage guitars and keyboards, but also sells a range of ancillary products such as amplifiers, strings, tuners and keyboard stands.

Direct importing

JB HiFi is now selling cameras and accessories directly from the manufacturers, with consumers generally not liable for GST on items under $1000, in direct competition with online only retailers. It’s likely that JB HiFi’s direct imports product range will expand over time.

New products

Technology has advanced so fast, who knows where the next hot electrical product will come from or be? In 2003, no-one foresaw Ipads. It’s likely that products in 2021 have not been envisaged yet. Will JBs be able to sell those products profitably? Probably.

JB HiFi NOW – Music streaming service

JB HiFi’s music streaming service is subscription based – starting from $25 for 3 months, which lets users stream and listen to music. It’s already a highly competitive environment, so it appears on first look that JB HiFi may have made a mistake with this move. Spotify is apparently ramping up to open in Australia. Rdio is the current market leader, with several competitors already in the space.

JB HiFi may be able to make the most of selling products to listen to music, and then signing customers up to JB NOW.

The main issue JB HiFI has, is that it doesn’t currently offer a mobile version of the service, whilst other competitors do. Mobile versions are apparently in the works, and should be available within the next month or so.

According to several review sites, JB HiFi’s NOW service is among the best, with licences to more than ten million songs and growing. It’s also easy to use, and comes with a few new technological innovations, that may enable it to stay ahead of the pack. NOW can canvass people you know and share some of the tracks they’re listening to with you. Most friends share similar music tastes, so this is a great addition to compile music you may be interested in.

I could also see JB HiFi NOW’s service expanded to allow renting and watching movies.

Risks

After reaching a peak in 2007/08, DVD sales and rentals (including Bu-Ray) have been steadily falling. I expect a follow on for devices used to play these items.

The main issue for JB HiFi is that many of its products are moving from a physical product such as a DVD, to a digital product, available online. Games can now be downloaded, rather than having to buy a physical DVD in a shop. Rapid advances in broadband speeds should result in DVDs being much more available in a digital format. However, only 26% of sales are in software.

Will people still buy music CDs? My guess is that they will go the way of vinyl records. Only a select niche group of people will buy them. However, they are likely to be around for a couple of years yet. Many people still have CD players and CD stackers in their cars, with no real digital alternative.

How about car stereos systems with internal digital storage and Wi-Fi? So you can download music to your car while parked near your house — JB HiFi will probably sell them.

The other issue is that over the past 9 years, sales of flat panel TVs grew enormously as people switched from analogue TVs to digital. JB HiFi cashed in on this successfully, but now needs to find other products with higher margins to replace this. I expect it to be successful in doing that.

Outlook

Weak consumer sentiment will pass at some stage. Competitors are falling like flies, as they have done over the last 9 years. While there will be a major move for many of JB’s products online, such as music, DVDs and games, I believe consumers will still need to shop for consumer electronics such as TVs, Ipods, Ipads, plus future devices along with all the associated accessories for some time yet.

The company still expects to roll out at least another 53 stores, and says that sales from recently opened stores are in-line with what they expected. In other words, saturation levels have not been reached yet.

With competitors falling all over the place, I think it’s likely that JB can roll out more than 53 stores.

The Foolish bottom line

JB HiFi has shown that it can rapidly adapt to new products and new categories. As the market leader with the lowest costs, I expect it to continue for some time. I think that the risks are overblown, and people have only looked at the recent past and extrapolated that out deep into the future.

While not a risk free investment, JB HiFi is trading on a forecast PE of 8.9, and with a fully franked dividend yield of 7%, the company looks cheap. Further reductions in debt, and increasing dividends also make it more attractive and I think the company is definitely worthy of further research.

Disclosure: I own shares in JB HiFi.

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4 Responses to JB HiFi: Is NOW the time to buy?

  1. Bret says:

    Thanks for the interesting article. I was not aware that they are selling musical products in the store such as guitars and strings. The one thing I would question for the time being is that their games will compete with EB and other game stores. I was comparing prices for PS3 games over Christmas and found that JB were very expensive and was kind of surprised by this.

    • surfingmike says:

      Hi Bret,
      THanks for your comments.
      That’s surprising to me too. i would’ve thought that JB’s would have been competitive with EB Games as well. I did mention in the article that EB Games subsidises the cost of new games through the sale of second-hand games. In other words, they can sell new games for lower prices than anyone else, because they are making a killing on second hand games.

      I suspect that selling the physical games on DVDs/CDs won’t be around much longer as gaming software transitions to an online model, so that will have negative consequences for both JB HiFi and EB Games.

      Cheers
      mike

  2. Matthew says:

    Hi Mike, I saw that JBH reduced there debt levels massively, but I get a debt to equity of around 50% with debt of 103 mill. and equity of around 207 mill. Are you taking into account cash to get the 21%?
    Cheers,
    Matt

    • surfingmike says:

      Hi Matt,

      Yep – JBH have 58.7m in cash and cash equivalents on the balance sheet, which gives them net debt of $44.8m. This compares to Net Debt of $205.3m (including $27.2m of cash) as at end of June 2011.

      Cheers
      Mike

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