Harvey Norman vulnerable amid housing downturn, online competition
Harvey Norman's strength as a bricks-and-mortar discretionary retailer is vulnerable as it faces long-term structural and cyclical challenges, Morningstar says.
Harvey Norman's (ASX: HVN) strength as a bricks-and-mortar discretionary retailer is vulnerable as it faces long-term structural and cyclical challenges, Morningstar says.
In his 
latest note, retail analyst Johannes Faul says the company, which generates just over half of its operating profit from Australian discretionary retailing, is exposed in the event of a cyclical slowdown in the Australian housing market and the anticipated growth of US online giant Amazon.
Morningstar's assessment comes as a dairy venture part-owned by Harvey Norman has been put up for sale, three years after the retailer bought into it on the recommendation of founder and chairman Gerry Harvey.
Harvey Norman benefited from Australia's turn-of-the-century housing boom and the first-home owners grant, which prompted some home buyers to draw funds against their properties and funnel them into consumer discretionary items. But this trend is in decline, Faul says.
"The global financial crisis in 2008 put a sudden stop to the growth rate, with consumers delaying, and eventually reassessing expenditure intentions," Faul says.
"The recent housing boom has masked some of the structural declines facing Harvey Norman's business; however, any cooling of the cyclical housing market will likely reverse this trend."
Longer term, Faul expects the company will struggle to produce a return above its cost of capital over the next decade amid weak retail conditions as consumers look to pay down debt.
Another threat to Harvey Norman dominance is the trend for consumers to research and compare products online. The company has sought to boost its omnichannel presence, but consumers are increasingly looking for the lowest price and show little domestic online brand loyalty. Ultimately, Faul fears the company could become the shopping window for cheaper online offers.
"Consumers view Harvey Norman as a bricks-and-mortar brand, and some, rightly or wrongly, assume they can find lower prices for products online," Faul says.
"Because of this perception, consumers may avoid visiting the Harvey Norman website, instead using a search engine to review products, and make use of online price comparisons to seek the best price.
"We view this as a significant risk that revenue could be under pressure as consumers increasingly direct expenditure to online competitors, making it difficult for retailers like Harvey Norman to produce a rate of return above their cost of capital."
Sales in highly commoditised consumer electrics and home appliances account for about two thirds of franchisee sales, and are the most vulnerable to online competition, Faul says.
Despite these headwinds, Faul believes the company's scale allows it to compete successfully long-term and defend its market share. However, he describes opportunities for growth above and beyond market growth as "limited".
Morningstar increased its fair value estimate for Harvey Norman in August 2017 from $3.30 to $3.40 following solid full-year results. At current share price the stock is trading at fair value.
Call for buyers of farm venture [AAP]
The real estate agency running the intended farm sale, Elders Real Estate, said on Monday it was calling for expressions of interest in Coomboona Dairies in northern Victoria's Goulburn Valley.
Harvey Norman hired receivers for the dairy farm in March, a month after saying writedowns on the farm had contributed to a decline in first-half profit.
Harvey Norman's first-half profit dropped 19 per cent to $207.7 million, which included a $20.7 million impairment on a dairy investment that attracted the ire of shareholders and confusion from analysts.
The disappointing first-half result triggered a major share sell-off on February 28, wiping $635 million from the retailer's market value.
Harvey Norman paid $34 million for a 49.9 per cent stake in Coomboona in September 2015, but gave no reason for its interest in its notice to the Australian stock exchange.
The farm - which is being offered as a whole or as two holdings - produces more than 30 million litres of milk annually from about 2,500 Holstein cows.
Elders anticipates significant interest from both private and institutional investors.
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Emma Rapaport is a reporter for Morningstar Australia
With Lilly Vitorovich, AAP
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