Running the ruler over Harvey Norman

Leyland Private Asset Management

Harvey Norman Holdings Limited is an Australian based multinational business whose principal activities primarily consist of an integrated retail, franchise, property and digital enterprise.

Harvey Norman Holdings Limited grants franchises to independent proprietors under three leading brand names: Harvey Norman, Domayne and Joyce Mayne, as well as operating company owned and operated stores. Harvey Norman delivers a diverse range of products including electrical goods, furniture, computerised communications, bedding and manchester, kitchen appliances, small appliances, bathroom and tiles, carpets and flooring.

There are 194 franchised complexes based in Australia and a total of 87 company operated stores located domestically and abroad - including locations in New Zealand, Singapore, Malaysia, Ireland, Northern Ireland, Slovenia and Croatia. The consolidated entity operates 281 stores in eight countries across the globe with Australia being the anchor geographical location, followed by a market-leader position in New Zealand and strengthening market presence in Singapore, Malaysia, Ireland, Northern Ireland, Slovenia and Croatia.

FY17 Result

• PROFIT BEFORE TAX : $639.81m (up 29.6%)

• NPAT : $373.25m (up 18.6%)

  • Franchisee Aggregated Sales Revenue was $5.62bn up 5.4% on previous year:

Franchise Stores

*Sales Revenue was $5.62bn up 5.4% on previous year

*Earnings rose almost 14% to $304.5m up from $268.15m

*Franchise fees rose 5% to $811m

*Outstanding loans to franchises fell from $943m to $935m

*HVN provide tactical support to franchises - including loans, rental assistance etc.

*Tactical support given was $64.5m which has come down from $125m during the GFC. Gerry Harvey has stated he will bring down this figure to $25m.

Company Owned Stores

*Company-operated sales revenue of $1.83bn up 2.1% on previous year

*Earnings from company owned stores increased by 24.3% to $91m

*Standouts were Singapore and Malaysia, where earnings increased by 70% to $19m

• Non-core business operations were -$9m vs $18m last year.

*Non-core businesses include a dairy business and mining holdings. Gerry has since indicated he is existing the dairy operation.

Property Investment Portfolio

The ownership of a robust, high-quality and sustainable property portfolio valued at $2.66 billion is the linchpin to a successful franchising and retail strategy as it delivers a steady and reliable income stream and generates strong capital appreciation. The investment property portfolio in Australia has a net property revaluation increment for 2017 of $107.38 million and a fair value of $2.24 billion. The perceived risk to the property valuation is a downturn in retail, and the rents that will accrue to property owners in the event that retailers come under pressure – impacting their ability to sustain rental payments. Composition of Total Assets of $4.19m Keeping in mind the market capitalisation of HVN is $4.37bn

Flagship Store Initiative

A significant initiative is the development of a franchised flagship complex in Australia and a flagship store in each of the seven overseas markets. Each of the Flagship stores and the franchised Flagship complex is designed to provide an unrivalled customer experience in terms of store design and premium product offering. The initial success of the Flagship strategy is evident in the result generated by the company-operated retail segment located in the seven offshore markets where profit before tax for the year ended 30 June 2017 increased by 30.8% to $100.86 million from $77.09 million in the previous year. When the results of the other non-franchised retail brands in Australia are included, the result before tax of the company-operated retail segment increased by 24.3% to $90.85 million from $73.11 million in the previous year.

Risks

There are key risks impacting the discretionary retail environment:

• High level of household debt susceptible to rising interest rates

• Rising cost of living impacting discretionary spending

• Existing competitive environment, alongside the pending Amazon effect.

Amazon – is a huge perceived risk to Australian retailers. HVN management has indicated that they will price match Amazon, which will adversely impact margins. Our view is that the risk of Amazon has been overstated in the near-term. Our population is far more disparate than Amazon’s key market in the US. For example, Amazon has taken 3% market share in Canada. While competition in retail is expected to intensify, we see an opportunity in HVN given the depressed valuation and scope for capital management. HVN is currently trading at a 20% discount to their relative historical level.

Price / Earnings versus 5-year average:

Peer Group Comparisons

The retail sector trades at a steep discount to the broader market, largely due to the risks highlighted above.

Peer Group Comparisons

The retail sector trades at a steep discount to the broader market, largely due to the risks highlighted above.


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