Harvey Norman’s earnings will fade over the next two years, but the
company is on good shape and still offers value.
HVN’s 1H22 sales were down 6.2% and profit before tax also down 20.5% (excluding property revaluations) compared to the same period last year. But the previous comparable period was notable for its extraordinary circumstances during the peak lockdowns and restrictions imposed by state governments due to the pandemic.
The 1H22 period was still affected by lockdowns which kept sales flat up until November and December when conditions improved. The impact of this will be to send more of the annual profits into the second half year than is usual. HVN has good control of its costs, and its inventory position is lean without being short, so we think 2H22 should be a reasonable outcome.
The company’s marketing spend was trimmed 11% compared to the same period last year. At $174.5 million in 1H22, the company spends heavily on this aspect, and it is an area than can be controlled depending on the sales environment. Wages and salaries increased 7.6% to $193.9 million in the period.
HVN’s inventory position at the end of 1H22 was $559 million compared to $479 million as at 30 June 2021. Like other retail companies, the higher inventory levels is likely to be a response to supply chain issues and companies not wanting to get caught short of stock. HVN’s inventory looks lean to us so we are not concerned about the increase. Total working capital in 1H22 was $846 million which was down 2% on 1H20 levels compared to HVN’s global sales growth of 17% over the last two years. This measure is relevant to HVN from an inventory perspective as the company extends loans to its franchisees to buy stock which is recorded as receivables.
Investment view
HVN’s earnings can be expected to fade through to FY24f after the bumper period through the pandemic. However, we see upside in the share price as the market appears to have a more severe earnings fade than we think is justified.
The company has a good balance sheet (net debt is just $62 million as at 31 December 2021) and sales will be assisted by inflation. Consumers still have plenty of cash available, some of which will find its way into a new TV or fridge. We know that sales trends so far in 2H22f are fairly robust. Like-for-like Australian sales are up 1.5% in Australia for the first 7 weeks of 2022. With restrictions now absent (fingers crossed), this will get foot traffic back in stores.
One point to consider is the attractive net dividend yield of more than 6%. If the company maintains a payout ratio of 70-80%, the dividend could rise. Consensus forecasts do not agree.
Risks to investment view
The prospect of rising interest rates could impact the housing market which would in turn impact furniture sales for HVN. If the economy slowed down and consumer confidence was lower, then HVN’s sales might be affected. Higher interest rates could also impact HVN’s property portfolio, and the capitalisation rate applied.
Recommendation
We have retained our Buy recommendation.
