Fiscal 2024 was a year to forget for the Australian retailing sector, and no-moat Harvey Norman (ASX:HVN) wasn’t exempt from the challenging marcoeconomic environment. In its largest overseas market, New Zealand, it was even worse. Consumers across the Tasman are hurting more, with elevated cost-of-living pressures compounded by even higher interest rates than in Australia and declining house prices reversing the wealth effect.

Underlying pretax profit dropped by 21% on the previous corresponding period, or PCP. Reported EPS missed our estimate due to higher-than-expected tax payments following a tax law change in New Zealand in April 2024. However, the fall in underlying operating profits to AUD 540 million met our expectations.

We maintain our earnings estimates and continue to forecast a rebound in sales and earnings from fiscal 2025, as global consumer demand strengthens, with lower interest rates coming to pass the critical factor. We estimate pretax margins recovering to long-term maintainable levels at around 16% by fiscal 2026 versus an estimated 13% in fiscal 2024.

We increase our fair value estimate by 2% to $4.10 with the time value of money. The shares screen as overvalued but are better value than its household goods retailing peer JB Hi-Fi. Based on our fiscal 2025 EPS estimates, Harvey Norman trades on a P/E multiple of 13—a huge discount compared with JB Hi-Fi at 19.

We agree with CEO Katie Page that tax cuts and energy rebates are likely to boost retailing sales. We anticipate a greater number of employed Australians and higher wages to further underpin solid growth in fiscal 2025. (For more details on industry trends and near-term sales drivers, please see, "Industry Pulse: Australian Retailing 2024 Q2," published on July 1.)

Consumers are already spending more on nonessential goods. Sales growth is improving at discretionary retailing chains operated by no-moat Super Retail and at narrow-moat Woolworths’ Big W discount department stores.

Business strategy and outlook

Harvey Norman predominantly sells commoditized branded electronics, such as televisions and computers, home appliances, and furniture. We expect the growth of the Australian consumer electronics market to lag overall consumer spending because of constant deflation driven by intense competition. Headwinds continue to mount as internet research and price comparisons threaten Harvey Norman's brick-and-mortar peers. In the core Australian market, Harvey Norman must compete on price with online offers, despite offering its customers in-store service and advice.

Behavioral changes following the pandemic have driven even more consumers to the online channel, in which Harvey Norman has a relatively weak platform in Australia after years of neglect. However, Harvey Norman has recognized the importance of e-commerce in meeting customer expectations, and is assisting its Australian franchisees in implementing their online-to-offline, or O2O, strategy.

Retail property ownership has been a preference for Harvey Norman and its property portfolio is valued at around AUD 4 billion. The company continues to view ownership as providing income security. We take a different view, and would prefer this capital to be reinvested in growth opportunities or returns to capital shareholders.

We expect the benefits from owning retailing property are eroding. Strong Australian e-commerce sales growth from an already meaningful base—over 15% of all retailing is transacted online—is likely to drive declining brick-and-mortar sales industrywide. Even if Harvey Norman's brick-and-mortar channel posts real sales growth, soft sales at physical stores overall, are likely to weigh on demand for floor space, and weakening property valuations over time. We expect the rising interest-rate environment to put downward pressure on the book value of Harvey Norman's property portfolio as capitalization rates gradually adjust.

Harvey Norman bulls say

  • The franchise business model promotes entrepreneurial leadership aimed at evolving product offerings to match the demands of consumers.
  • Harvey Norman has been thriving while many of its smaller competitors have exited the market due to significant price deflation across the computer and television product segments. Continuing this success should ensure that Harvey Norman retains its market-leading position.
  • Harvey Norman's property division continues to deliver relatively defensive cash flows and presents a significant tangible asset.

Harvey Norman bears say

  • The Australian franchisee model could be at a disadvantage in the online channel versus company owned omnichannel competitors and pure-play online retailers.
  • Earnings from the large property portfolio could be at risk of subpar growth, if growth in footfall is anaemic and retail landlords adjust rents accordingly.
  • The firm dismissed the possibility of e-commerce disrupting its physical store network for many years. Harvey Norman must now play catch up in Australia in the presence of quickly expanding JB Hi-Fi, Catch Group, Kogan, and Amazon Australia.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.