The market is bullish on JB Hi-Fi, is this unwarranted?
The stock soared to an all-time high. What do we think?
Mentioned: JB Hi Fi Ltd (JBH)
After a 20% shortfall in earnings, JB Hi-Fi’s (ASX: JBH) stocks gained 7%. Investors showed confidence in the retailer’s future; however, it is currently at a 61% premium to Morningstar’s Fair Value assessment (at 12 February 2024).
Above: JB Hi-Fi’s Price-to-fair value. The stock has not entered undervalued territory in the last 10 years. (Source: Morningstar Investor).
JB Hi-Fi (ASX: JBH) is one of Australia's largest retailers, having built a strong brand and market leadership within the consumer electronics industry, after the demise of smaller players, and more recently of major competitor Dick Smith Electronics. Australians have been quick to adopt the latest technology during the past decade, thanks largely to high employment and low interest rates.
Consumers are keeping spending up by saving much less than usual. We don’t imagine this to become the norm. We expect the savings rate will start to creep up again and those funds will be redirected from nonessential items like consumer electronics and home appliances. In its latest economic forecast, the Reserve Bank of Australia expects the savings rate to gradually increase to close to 3% in the June half of 2026, from just under 1% in the December 2023 half. This is still a far cry from the 6% average household savings rate in the decade prepandemic.
Profit margins are deteriorating significantly. We expect intense competition, mid-single-digit hourly wage increases, and soft demand to drive net profit margins back to prepandemic levels by fiscal 2025. In the first half of fiscal 2024, net profit margins collapsed by over 1.1% compared with the previous corresponding period.
It’s not all bad news. The results showed that JB Hi-Fi’s underlying sales momentum improved slightly despite the cost-of-living crunch. Morningstar raised the fair value estimate by a modest 3% to $37.50 per share. The earnings forecasts for fiscal 2025 are virtually unchanged.
As mentioned, profit margins are deteriorating. This aligns with Morningstar viewing JB Hi-Fi as a no-moat stock. Our analyst, Johannes Faul, believes that it does not have the ability to protect and grow its earnings over the long-term. Although JB Hi-Fi has a strong brand and high foot-traffic with consumers, competition remains significant from Amazon, Kogan and Catch.
These online retailers operate in an environment of very low fixed operating costs, with technology providing a 24-hour shopfront and no need for expensive leases or sales staff. The lower operating cost enables digital retailers to deliver products at a compelling price and offset JB Hi-Fi's scale advantage. JB Hi-Fi’s offering is also not differentiated enough to justify selling products at a premium retail price. The company competes on a global stage in online, with the distinct disadvantage of corralling a domestic population of around 25 million, compared with those from the U.S., servicing more than 330 million.
At current prices, shares screen as materially overvalued. We think we are more cautious than the market on maintainable net profit margin levels and the sales growth outlook for the category. Once demand levels normalise, we forecast an average annual sales growth of 3% from fiscal 2026.
How should investors think about JB Hi-Fi's earnings announcement?
Investors must remember that on the other side of every buy trade, there is a person or institution that believes the prospects of the stock are unfavourable. The same goes for sell trades - you're selling to a party that believes that they should own that business. During earnings announcements, it is easy for investors to get swept up in the constant news and PR written ASX announcements that try to sugarcoat the results as best as possible.
It is for us to determine firstly, whether the stock is the right fit for your portfolio. Secondly, it is determining whether you believe in the prospects for the business. Confirmation bias can occur during these periods of the year where we want to believe that the stock is right for us, especially if it is the general consensus of other investors and investing news sources. It is hard to resist projecting promising results and picking up a stock for a relative song.
There are ways to reduce this confirmation bias. A useful and practical exercise is creating a 'bulls' and 'bears' list. It will either strengthen your thesis or help prevent impulsive purchasing. Our analysts have conducted this exercise for JB Hi-Fi below.
