Harvey Norman (ASX: HVN) is one of Australia’s household retail names with a large physical presence in the ANZ region and parts of Asia and Europe. The company has been suffering over the past couple of years from a cost of living crisis that crippled demand and rising interest rates which pushed asset valuations lower.
However, an easing macro environment combined with a massive electronics and home upgrade cycle due to both the passage of time since the 2021 boom, the advent of Gen AI devices, and lower rates have poised the stock for a re-rating.
Table of Contents
- 1 About Harvey Norman
- 2 Strong And Resilient Business Model Are Strengths
- 3 Macro Sensitivity Is A Weakness
- 4 AI Presents Huge Opportunity For Sales And Operations
- 5 Geopolitical Environment Is A Threat
- 6 Harvey Norman Financials
- 7 Harvey Norman Valuation
- 8 Conclusion – Substantial Operating Leverage To Kick In With Easing Monetary Policy
About Harvey Norman
Harvey Norman (ASX: HVN) is an electronics and lifestyle retail brand with a massive presence in ANZ and a reasonable presence in Asia and Europe. The company owns a massive prime real estate portfolio and operates on a hybrid franchise and company-owned model.
Harvey Norman mainly operates the franchise model in Australia while foreign country operations are company-owned. In Australia, the company owns almost all real estate under its stores and leases them out to franchises while foreign operations are a mix of rental space and owned real estate.
Harvey Norman mainly operates in the Large Format Retail Segment across three brands – Harvey Norman, Domayne, and Joyce Mayne.
At the time of writing, Harvey Norman has a market capitalization of A$6.279 billion.
Source – Harvey Norman 2024 Annual Report
Strong And Resilient Business Model Are Strengths
Harvey Norman’s (ASX: HVN) biggest strength is its efficient and multi-faceted business model.
Harvey Norman’s franchise business model combined with ownership of prime real estate assets brings it capital efficiency and a strong balance sheet to fuel growth.
The company’s asset base consists largely of a portfolio of real estate assets, mainly in Australia with international stores making up about 15%. This allows the company to focus on strategy and growth without using resources for day-to-day operations.
The franchise model combined with a massive real estate portfolio allows the company access to leverage at attractive rates due to a strong balance sheet and cash flow resilience.
Source – Harvey Norman 2024 Annual Report
Under the franchise model, in which the company operates in Australia and makes up the bulk of its operations, the company leases out space at one of its locations/shopping complexes to franchisees who conduct business under the Harvey Norman, Domayne, and Joyce Mayne brands.
This brings Harvey Norman advantages such as not having to worry about day-to-day operations such as increasing sales, managing inventory, managing a huge salesforce, etc. which are left to franchisees and focus resources on the company’s growth and strategy.
At the same time, the company is able to navigate the cyclical nature of the retail sector much better as real estate assets reprice well in relation to interest rates and inflation.
This is best reflected by the way its real estate portfolio could tide over higher rates due to increased income from franchise rent. (Real Estate is valued as Net Income From Rent/Sales divided by interest rates minus growth. Higher rates and low growth reduce valuation, but this was offset by higher income from rent/sales due to inflation).
Further, the company’s prime real estate portfolio is also used by marquee retail brands across various sectors of both discretionary and non-discretionary kinds. This gives the company’s revenue diversification benefits and some protection against dips in owned brand sales.
The company’s product portfolio comprises large ticket value low-frequency items, which customers prefer to purchase in person. The company’s vast retail presence also allows the company to offer various omnichannel sales models to customers compared to online-only companies.
Lastly, we are at the top of the rates and inflation cycle, which is a huge tailwind for companies like Harvey Norman which are heavily leveraged to consumption. An easing rate would decrease mortgage payments and credit card bills.
This has huge implications for the company as demand over the last few years has suffered from a cost of living crisis which caused customers to cut back on large purchases. However, with the easing cycle having begun and customers facing the end of a product cycle, demand should return strongly.
The return of demand and lower rates will also boost demand in overseas locations as they too have been suffering from either high rates faced by consumers or low exports in emerging economies such as Malaysia where the company has a serious presence.
Macro Sensitivity Is A Weakness
A serious weakness of Harvey Norman (ASX: HVN) is that its goods are largely high-value consumer discretionary items whose demand is very elastic and dependent on economic conditions.
The past couple of years have shown the company’s sensitivity to inflation and interest rates (which impact the value of big fixed assets such as real estate).
Should inflation fail to moderate as fast as expected and interest rates remain higher for longer, the company’s operational improvements may take longer to materialize and weigh down on the stock.
AI Presents Huge Opportunity For Sales And Operations
Harvey Norman’s (ASX: HVN) major opportunity ahead is the onset of Generative AI as it will invigorate demand for new electronic devices and provide valuable efficiency gains to the company’s operations.
For starters, the onset of Generative AI is one of the largest new megatrends of the past couple of decades as it will change the capabilities of gadgets and unleash a wave of new product types across wearables, appliances, and personal devices.
The new and innovative products that AI will bring to market will invigorate demands for upgrades by customers who have been cutting back over the past few years due to high bills.
Source – Harvey Norman 2024 Annual Report
This will be bolstered by spending on home spending which has also suffered over the past few years as home appliances and IoT devices are rapidly integrating new AI capabilities.
The company is charged to capitalize on these opportunities and has stated that they are making investments in stores and training personnel to better showcase AI features and products to customers.
Finally, AI presents serious opportunities for the company to unlock efficiency gains through deployments across customer services and operations. AI could unlock savings or improve sales through better analysis of data and optimization of various core functions.
At the same time, AI chatbots and agents could transform customer services through faster, bespoke, 24/7, and accurate resolution of customer queries at lower costs. AI could also transform customer services for items such as furniture and lifestyle items which involve assembly/setup by creating interactive AR/VR assistance for customers.
Geopolitical Environment Is A Threat
A major threat facing Harvey Norman (ASX: HVN) is deglobalization and the raising of tariff barriers across the world. The recent geopolitical and global events such as COVID and wars have shown cracks in major economies’ supply chain resilience and have prompted a spectrum of responses as solutions.
Donald Trump’s recent re-election and promise of imposition of steep tariffs on imports will reshape global supply chains and impact/increase pricing of a variety of goods, mainly electronics which is one of Harvey Norman’s mainstays.
At the same time, deglobalization will impact the economic prospects of some countries such as Malaysia which were very dependent on exports to fuel growth. The raising of tariffs in retaliation by the EU/UK will also hurt the company’s prospects in Europe.
Harvey Norman Financials
For FY24, Harvey Norman’s (ASX: HVN) total sales, encompassing both overseas company-operated stores and Australian franchise sales, reached $8.86 billion.
Consolidated revenue was $4.11 billion, down 3.9% from the previous year, but still up 20.2% compared to FY19, representing a 3.7% compound annual growth rate over five years.
The company reports under three segments – Franchising Operations Revenue, Overseas Operated Stores Revenue, and Property Revaluation. The first two have been introduced earlier in this report while the third is the revaluation impact of the company’s real estate assets, which are mainly non-cash charges.
Source – Harvey Norman 2024 Annual Report
Profitability declined significantly. Reported profit before tax (PBT) was $592.96 million, a decrease of 17.8% year-over-year. Excluding property revaluations, PBT was $540.07 million, down 20.6%.
Segment performance varied. Australian franchising operations generated $273.56 million in PBT (excluding property revaluations), representing 50.7% of total PBT. This segment’s PBT decreased by 26.7%, and its margin fell from 5.82% to 4.52%.
Overseas company-operated retail contributed $118.54 million (22% of total PBT). The property segment’s PBT was $160.56 million (29.8% of total PBT), a 40.9% decrease from the previous year’s $271.66 million.
Reported profit after tax (PAT) was $352.45 million, a substantial 34.7% decrease. Adjusted PAT, excluding property revaluations, and a New Zealand deferred tax adjustment, was $372.85 million, a 21% drop.
Operating cash flow increased slightly to $686.53 million, up $6.27 million from FY23. Net assets increased to $4.54 billion, up $70.44 million. The net debt-to-equity ratio was 14.49%. Cash conversion improved from 97.4% to 100.4%.
Harvey Norman’s capital management strategy aims for long-term shareholder value, optimal returns, and low-cost capital, targeting a net debt-to-equity ratio below 50%. As of June 30, 2024, they had $242.16 million in unused financing facilities out of $1,182.27 million in total approved facilities.
Harvey Norman Valuation
We will be comparing Harvey Norman (ASX: HVN) to electronics and lifestyle retailers JB Hi-Fi (ASX: JBH) and Nick Scali (ASX: NCK). Both are mainly ANZ region players and operate in segments overlapping with Harvey Norman and its sister brands.
As you can see, Harvey Norman is most reasonably priced in terms of price ratios to peers despite growth being only slightly lower compared to JB HiFi and about half of Nick Scali. However, this is off a much bigger base.
While the company lags on ROE, it is because Harvey Norman has a huge real estate portfolio on its books. This is also visible in the super cheap Price/Book, which will also be repriced at lower rates.
Lastly, the company has a healthier dividend yield and a business model that better supports returning cash to shareholders over traditional retail models.
Conclusion – Substantial Operating Leverage To Kick In With Easing Monetary Policy
Harvey Norman (ASX: HVN) is a strong retail brand with a resilient business model that is primed to benefit from an improving macro environment.
The company is also poised to benefit from a serious re-rating of its real estate holdings as lower rates will push asset values upwards which combined with higher revenue and rent from franchises should bring substantial operating leverage.
Overall, the company is a reasonably low-risk play leveraged to consumption, which makes it a great proposition in the current macro-environment.
