JB, you’ve done it again!
We had a look at the JB Hi-Fi deal to acquire The Good Guys this week. The numbers look impressive. It’s taken a long time to stitch this up and we think JBH management deserves a pat on the back. That might surprise some of the readers because we have been negative on JBH’s valuation in the past few weeks. So let’s explain a little further.
We have no grievance with the JBH business model. Since coming to market, the business has consistently delivered on promises and built itself into a formidable force within an industry of consistent failures. JBH in a very similar way to Bunnings has been able to clearly establish its strategy and remain relevant to its audience. Growth has been excellent, the balance sheet well maintained and guidance has almost always been achieved.
There aren’t too many Australian retailers that can make the same claim. Not even Woolworths given its recent misfortunes. But back to our grievance with JBH – the valuation. The numbers always look over stretched and somehow, someway, JBH makes them work. Management delivers, the market gets it right and the stock continues to rise.
The Good Guys acquisition was made at a very high price – but still at a multiple discount to JBH’s valuation. The capital raising to fund the deal also made with pinpoint accuracy – a very small dilution factor, small discount to recent market price and underwritten to ensure no real problems. This ticks a lot of boxes.
But the laws of nature always prevail and JBH is no exception. The business has huge operating leverage – it generates several billion dollars of revenue and operates on a very slim mid single digit operating margin. The acquisition adds scale, will make it bigger and provides opportunity to take out a competitor while both businesses are still very healthy. Diversification improves, but operating leverage is still very large. Expectations are high, there is almost certainly no margin of error.
Which makes valuing and investing in JBH extremely difficult. After a lot of hard thought and discussion, we’ve decided to classify JBH as a spectator stock. We’re happy to sit on the sideline and let it do its thing. If it executes well on this deal again, the future continues to remain bright and perhaps it can take on more ambitious growth. But if the operating leverage works the other way – for whatever reason – the stock may finally face punishment for having a hefty valuation.
Our focus remains on finding trades and investment ideas with a higher degree of certainty and with a lower risk/reward profile. There are many of these opportunities in the Australian market. JBH is not one of them.
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Chief Market Analyst
Peter Esho is a member of Invast’s Investment Committee and Chief Market Analyst at Invast Financial Services in Australia. The Invast’s Investment Committee constructs professionally constructed global thematic portfolios of Direct Market Access (DMA) CFDs over highly liquid global shares and ETFs through its new PortfolioInvestor platform. Since 1960, the Invast Group has grown to become one of the largest and most successful global brokerage firms, offering state-of-the-art trading technology and unparalleled service catering to all levels of traders.
Invast Financial Services Pty Ltd (ABN 48 162 400 035) is regulated by the Australian Securities and Investments Commission and holds an AFS Licence 438283 which authorises it to carry on a financial services business in Australia.