One of these Amazon targets not like the other
In our final instalment on Amazon's effect, these two retailers are the most vulnerable to Amazon's imminent "hard" launch in Australia, and both will adapt differently.
For all the hand-wringing, the local launch of Amazon leaves room for the largest, most successful incumbent leaders in the consumer electronics and home appliance retail space, says Morningstar equity analyst, Johannes Faul.
Previous articles in this series looked at a fast-food segment leader, Domino's (part one), and the dominant grocery chain businesses Woolworths and Coles (part two).
We now turn to the largest local target on Amazon's radar: consumer electronics retailers.
Within this space, Amazon currently holds around 15 per cent market share, and Faul tips its online sales penetration to hit 50 per cent by 2020.
With consumer electronics and home appliance sales accounting for 68 per cent and 86 per cent of sales for Harvey Norman (ASX: HVN) and JB Hi-Fi (ASX: JBH), respectively, in 2016, these two companies are particularly vulnerable.
While JB Hi-Fi CEO, Richard Murray, has consistently refused to directly mention Amazon, he's stuck to the line that "competition makes you better".
He has also emphasised the company's investment in digital sales channel improvements--a soft reference to Amazon, perhaps--including during an earnings call with analysts in mid-August.
"We continue to invest online. Sales in Australia grew 38 per cent to 3.8 per cent of sales, up from 3.1 per cent in the prior year," with positive increases in "online traffic; site speed; average transaction per user; delivery times; and customer service queries".
"Our recent sales momentum has enabled us to invest in a range of initiatives," he said.
According to Morningstar's Faul, the company's fair value estimate (FVE) of $23--currently trading at near parity-- is based on it successfully adapting to e-commerce trends. This is hurt somewhat by its Good Guys acquisition, with lower margins than parent JB Hi-Fi.
Given the low-margin and highly competitive retail sector, neither company is regarded by Morningstar as holding an economic moat.
Regarding the entry of Amazon and its disruptive effect, Faul says: "We expect the newcomer to operate as a pure e-commerce player, accelerating the growth in the relatively small but quickly growing online channel."
"We forecast that sectors with already-high online penetration, such as consumer electronics and home appliances, will remain vulnerable," he says.
"JB Hi-Fi, as an Australian industry leader in consumer electronics and appliances, is adapting to the ongoing trend of consumers switching to e-commerce."
Harvey Norman remains slightly above Morningstar's $3.40 FVE, with $4 the last closing price--"the market is still extrapolating benign current trading conditions".
"Its vested interest in physical stores could hinder its progress in e-commerce," Faul says.
"The defensive nature of the retail property portfolio is overstated, as lower tenant profitability would likely result in rent reductions or vacancies. Also, its vested interest in its physical stores as a landlord could hinder its focus on the growing e-commerce instead of a stagnating brick-and-mortar channel," he says of Harvey Norman.
According to Faul, Harvey Norman will "struggle as many consumers migrate to the online channel, where it is under-indexed".
"The online door is now wide open, and domestic competitors are forced to adapt to international prices," he says.
"We think Harvey Norman and JB Hi-Fi, the Australian industry leaders in consumer electronics and appliances, will adapt to the ongoing trend of consumers switching to e-commerce," Faul says.
"We estimate the companies to grow like-for-like sales in line with the overall growth rate of the sector, but we caution that the market appears to be pricing in a more optimistic scenario for Harvey Norman, in particular."
Morningstar subscribers can access the full report on Australian electronics retailers.
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Glenn Freeman is a senior editor at Morningstar.
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