The recent move by JB Hi-Fi to acquire The Good Guys has a lot of investors excited. Largely, it seems, because the tie-up will help consolidate the retailer’s pricing power in an already concentrated industry. But while we’re happy to shop there, we’re not yet convinced JBH meets our investment criteria. In this longform wire, we explain we can’t quite see a value case for investing in JBH just at the moment.
One of the time-honoured traditions of the Australian corporate landscape is the maintenance of oligopolistic market structures that make life that little bit easier for the entrenched players. In important industries like banks, telecommunications and supermarkets, we tend to see a relatively small number of strong players, and big gaps between the stronger players and the less so.
This is probably a fact of life in a market the size of Australia’s. In many cases there simply isn’t enough space to allow for a large number of large full-scale, efficient players. Markets can certainly evolve and be disrupted (Aldi being a good example in the supermarket industry), but oligopolistic market structures like this tend to be enduring in a market like ours.
This is not always a great outcome for consumers, who would probably benefit from a bit more competition, but as investors, we need to pay attention to the economic benefits that accrue to shareholders in favourable industry structures.
With this in mind, we have watched with interest the acquisition by JB Hi-Fi of The Good Guys. Electronics retailing in Australia is already a somewhat concentrated industry, especially following the demise of Disk Smith, and this transaction takes us a bit further down the industry consolidation path. Not enough to trigger ACCC issues, but a bit further down the path nonetheless.
This is not to say that JB Hi-Fi will enjoy dramatically increased pricing power following the acquisition, but it is interesting to note that profit margins for JBH are pretty thin, and it doesn’t take much of an increment to price to have a meaningful impact to overall profitability.
We can’t quite see a value case for investing in JBH just at the moment, but will be keeping a close eye on the way competition in the market evolves from here. If we end up having to pay a bit more for that next laptop computer, there may well be a case for taking a position on the other side of the till.
Contributed by Montgomery Investment Management: (VIEW LINK)
Tim is the Portfolio Manager of The Montgomery Fund – a concentrated, All-cap Australian equity fund that aims to generate capital growth and income. Montgomery focuses on owning high quality businesses and generating superior returns.