JB Hi-Fi Limited (ASX: JBH) primarily sells electronic equipment, but around 20% of turnover comes from software. This category includes CDs, DVDs and games and is in decline, with sales falling by 9% in the 2014 financial year. In spite of this, overall revenues were up 5% thanks to new store openings and diversification into new product categories.
The company introduced white goods and home appliances to its product range in 2012, and has since converted some of its electronics stores into dedicated home stores selling items ranging from washing machines and fridges to kettles and toasters. The strategy has been successful to date, with converted stores seeing a 10% growth in sales on average. The plan is to increase the number of home stores to 75 by June 2016.
Management hopes to leverage JB Hi-Fi's strong brand and conveniently positioned shops to win market share from other homeware companies such as Harvey Norman Holdings Limited (ASX: HVN). JB Hi-Fi's stores are situated in locations with high foot fall and benefit from impulse purchases. In contrast, competitors' stores are usually situated outside of town, requiring customers to make planned trips.
JB Hi-Fi has a large distribution network supplying 182 stores across Australia and New Zealand. This valuable asset will support the move to white goods and home appliances, and will be further bolstered when new facilities in Sydney, Melbourne and Brisbane are built this year.
An improved supply chain will assist with the newly formed Commercial and Education division, which is targeting $500 million in annual sales. Expansion into the commercial and education markets will further diminish dependence on the once-prosperous software business.
Some things are outside the control of management and a weakening dollar is problematic for JB Hi-Fi because most of its products are sourced abroad. This is countered by recent low oil prices, which if sustained, will provide consumers with more disposable income. Such factors fluctuate over the long term and so should not form the basis of any investment decision.
JB Hi-Fi has a healthy, fully franked dividend yield of 5% that has potential to grow in future years due to low debt levels and an undemanding payout ratio of 65%. A higher payout ratio would not jeopardise the financial strength of the company because it has minimal capital requirements.
JB Hi-Fi's return on equity (ROE) is extraordinary, averaging over 50% in the past four years. In comparison, smaller rival Dick Smith Holdings Ltd (ASX: DSH) has an ROE of 26% based on 2014 pro forma earnings.
Gross margins have remained steady at over 20% over the past few years. This demonstrates strong management given it would have been sorely tempting to discount prices in such a low growth environment.
Would I buy?
JB Hi-Fi has a price-to-earnings ratio of just 13 at the last closing price of $16.82, but retail stocks generally trade on low multiples due to the cyclical nature of the industry. Consumer sentiment has been poor over recent years, suggesting that we are close to the bottom of the current cycle. I would buy JB Hi-Fi at around $15 per share because at those prices it would have an earnings yield of 9%. This far exceeds returns available through risk-free term deposits and is likely to improve as the retail cycle turns.
