The yo-yo effect of lockdowns and recovery is on full display in Harvey Norman’s trading update. Spending is recovering as lockdowns end, setting the company up for a strong 4-month Christmas trading period.
Sales for the period from 1 July to 21 November were down 8.8% compared to the heightened activity of last year. Compared to the same pre-COVID period two years ago, sales are up 16.9%.
Since lockdowns ended in NSW and Victoria, we estimate that HVN’s same store sales have been close to flat. Conditions have also improved significantly in New Zealand, HVN’s second largest market. Ireland is improving but Malaysia remains hindered by restricted trading.
The fall in sales during lockdown periods would have been more harmful to HVN given its lower online penetration than other major retailers in electronics and furniture. The return of foot traffic into stores will help to rectify the lost or deferred sales into the key Christmas period.
HVN’s (unaudited) pretax profit for the four months to 31 October 2021 was $217 million, down 36% on last year but 70% ahead of the same period two years ago. This would mean that pretax profit margins have increased by about 450bp on two years ago. We think that better gross margins contributed at least a third of this margin gain with the rest from operating leverage.
HVN’s franchisee fees as a proportion of system sales are a good indicator of gross margins. We know that franchisee fees as a share of system sales were much higher in 1H21 than 1H19. We think the market is underestimating HVN’s 1H22f pretax profit.
Investment view
The longer term outlook for sales and gross margins needs to account for the outsized profits attained in FY21 during the peak of the pandemic. We think that HVN can retain about half of the extra sales and margin with varying degrees in the overseas markets.
We expect that earnings peaked in FY21 for HVN and EPS will fade over the next three years. But the improved industry structure is likely to lead to higher sustainable EBITDA margins in Australia. Overseas, HVN has further store expansion opportunities that will contribute to increased scale and will help lift margins.
HVN faces challenges in lifting its online performance given its franchising structure but we expect online to continue to grow. The pace of store rollouts overseas may also affect the earnings outlook along with FX and interest rate movement impacts on the company’s property portfolio.
HVN should benefit from inflation in electronics and furniture as well as elevated household savings.
Although HVN will have a declining earnings profile over the next three years, the quality of its asset base and sustainable EPS makes the stock appealing. Even with higher expected capex, the company can maintain an attractive 6% dividend yield.
We retain our Buy recommendation on HVN.
