Introduction
JB Hi-Fi Limited (ASX code: JBH) and Harvey Norman Holdings Limited (ASX code: HVN) are two Australian leading brands in retailing electronic products (The Australian 2010). Both of them enjoyed a time-honour business in Australian-the former was set up in 1974 and the latter in 1961. As to the differences, JB Hi-Fi is more specialised on personal digital and home entertainment products, while Harvey Norman has a wider range of products from personal gadgets, home appliances to furniture and beddings. In terms of scale, on 30 June 2010, Harvey Norman had 264 stores under its brand but only 194 of them were franchised (Harvey Norman Holdings Limited, 2010), whereas JB Hi-Fi owned all the 141 stores (JB Hi-Fi Limited 2010). In terms of overseas business, Harvey Norman had already set up 70 stores in New Zealand, Slovenia, Republic of Ireland and Northern Ireland, Malaysia and Singapore (all those 70 stores are directly owned by the Holding company), while JB Hi-Fi but had 10 stores in New Zealand.
As for the investors who are interested in retailing industry, both companies are undoubtedly in the candidate list. The report will concentrate on ratio analysis to provide recommendation on investment choice based on their performance in the year ended 30 June 2010.
Ratio analysis
Ratio analysis, as a method to compare financial performance and financial position of different companies, had been regarded as a handy instrument for investors. As early as 1960's such method had been utilised as a major means to extract value from the company's financial information (Horrigan 1978).
In this section, the profitability, efficiency, and financial stability would be compared between JB Hi-Fi and Harvey Norman based on ratio analysis. Note that all the detailed calculation of ratios can be found in the appendices.
Profitability
Gross profit margin
The gross profit margin measures the gross profitability by calculating the proportion of gross profit in revenue. Here, both companies increased their margin in 2010 a bit, and Harvey Norman enjoyed a 6% higher margin than JB Hi-Fi in both years, which implies that it had a better profitability in gross revenue.
Since gross profit margin is revenue minus cost of goods sold, a higher gross profit margin can be caused by higher selling price, lower cost of goods sold or both. Higher selling price means that Harvey Norman had better marketing strategy or more prevalent products; lower cost of goods sold implies that it had better inventory, supplier management or costing system of both direct material and direct labour. Generally, Harvey Norman had a stronger ability to earn gross profit.
Net profit margin
Both companies improved net profitability in 2010 compared with 2009 and it is noticeable that Harvey Norman had a staggeringly higher rate over JB Hi-Fi (about 20% in 2009 and 25% in 2010).
The primary reason behind the gap is that, besides retailing, franchising contributed a large proportion as other income items, which is not included in the denominator of calculating the net profit margin. If included, the Net Profit Margins for Harvey Norman would be 15% in 2009 and 17% in 2010 respectively. More importantly, franchising business means that Harvey Norman does not have to purchase inventory or spend salary to manage inventory for franchising revenue; therefore, the profit margin of Harvey Norman must be higher.
More meaningful information might be generated by comparing the net profit margin of JB Hi-Fi with that of Harvey Norman's retailing sector.
| | JB Hi-Fi Ltd (Consolidated) for years ended 30 June | Harvey Norman Holdings Ltd. (Consolidated) for years ended 30 June | ||
| | 2009 | 2010 | 2009 | 2010 |
| Net Profit Margin (Retailing) | 6.16% | 6.46% | -1.69% (1) | 1.74% (1) |
It can be found that JB Hi-Fi has better net profitability in retailing business while Harvey Norman has better overall profitability thanks to the franchising business.
Efficiency
Return on equity
Return on equity measures the capability of the company to make net profit using the equity it owns. JB Hi-Fi had a dominant advantage in this respect: it was able to earn 40 cents of net profit for each dollar of the equity while Harvey Norman could only make 11 cents.
Actually, the net profit of Harvey Norman was approximately twice as much as that of JB Hi-Fi, but its profit efficiency was lagged by the huge amount of retained earning which amounted to 1.8 billion and over 6 times higher than JB Hi-Fi. On a positive side, huge retained earnings means Harvey Norman had better financial position and liquidity as what will be discussed below. On the negative side, it means that Harvey Norman's investment and development is sort of stagnant.
Assets Turnover and Return on Assets
Both Asset Turnover and Return on Assets measure the efficiency by comparing assets with revenue or profit.
In terms of Asset Turnover, JB Hi-Fi could use one dollar of its assets more than 3.5 times every year to generate one dollar revenue at each time in 2009, and this figure increased to 3.8 times in 2010. On the other hand, Harvey Norman was much less efficient in using its assets, and the efficiency was even worse in 2010.
In terms of Return on Assets, each dollar of asset owned by JB Hi-Fi generated around 22 cents and 25 cents net profit in 2009 and 2010 respectively, whereas that by Harvey Norman only about 11 cents in 2010 despite 1 cent increase from 2009.
First of all, it can still be explained by that part of the assets in Harvey Norman was used in franchising business whose revenue was excluded in the Assets Turnover calculation. If counted such proportion back, the Assets Turnover would become 0.58 time in 2010. But still the efficiency of Harvey Norman in exploiting assets was far below that of JB Hi-Fi.
Inventory, Debtor and Creditors Turnover
These three ratios are key indicator of business's efficiency in utilising main current assets and handing main current liability (Mowen et al. 2007).
Inventory turnover compares the cost of goods sold during the fiscal year, whose major component is inventory, with inventory balance at the end of that year. The shorter the turnover days, the faster the company can sell the inventory for revenue (the more efficient). Comparing the two companies, JB Hi-Fi improved its efficiency in 2010 and it could sell all its inventory within 57 days-8 days quicker than 2009, while Harvey Norman was 41 days slower than JB Hi-Fi in 2010 and 7 days slower than itself in 2009. It is undoubtedly that JB Hi-Fi did a better job in efficient retailing and it explained why its net profit margin on retailing was better than Harvey Norman.
Debtor turnover measures the ability of company's efficiency in receiving cash from sales by comparing the revenue with the trade receivable balance at the year end. It is obvious that the debtor turnover in JB Hi-Fi is much faster than Harvey Norman. Generally, JB Hi-Fi only needed 1.34 days to settle the sales in 2010 and Harvey Norman needed 282 days. It is also noticeable that the efficiency in JB Hi-Fi was still improving while that of Harvey Norman was deteriorating.
Creditor turnover measures the number of days trade payable outstanding. Again, JB Hi-Fi settled its creditor much faster than Harvey Norman and was even shortening the outstanding days from 49 days to 44 days. Harvey Norman's outstanding days were around 250 days in both years.
With these three days, the Cash Conversion Cycle (CCC) of these two companies can be calculated.
| | JB Hi-Fi Ltd (Consolidated) for years ended 30 June | Harvey Norman Holdings Ltd. (Consolidated) for years ended 30 June | ||
| | 2009 | 2010 | 2009 | 2010 |
| Cash Conversion Cycle | 17.8 days | 14.34 days | 102 days | 132 days |
CCC describes the number of days a company needs to generate cash flows from the resources it owns. It is the key to the efficiency of the company as well as vital to the liquidity which will be discussed below. Here, JB Hi-Fi won by a great margin, in 2010 its cash cycle only cost 14.34 days while in Harvey Norman, it took 132 days. It means that JB Hi-Fi can generate cash flow much more quicker.
Financial Stability
Short-term (Current Ratio and Quick Ratio)
Comparing the current assets against current liabilities, those two ratios directly demonstrate whether a company has enough current assets to cover the current liabilities. Specifically, quick ratio is stricter than current ratio because quick ratio excludes the amount of inventory in the current assets owing to its lower ability to be exchanged into cash.
Comparing these two companies, Harvey Norman generally had a better short-term financial stability. In 2010 it had 1.62 dollars of current assets to cover each dollar of current liability and it improved significantly from 1.11 dollars in 2009. By contrast, JB Hi-Fi had 1.25 dollars of current assets to cover each dollar of current liability in 2010 and it worsened from 1.31 in 2009. As to quick ratio, Harvey Norman had a larger margin over JB Hi-Fi: the former had 1.43 dollar of quick assets to cover the current liabilities and the latter only had 0.33 dollar in 2010.
It could be found that both companies had no short-term liquidity problem and Harvey Norman had a better short-term liquidity condition than JB Hi-Fi because of the lower inventory level and higher trade receivable balance.
Long-term (Debt Asset Ratio, Debt Equity Ratio, and Times Interest Earned)
These three ratios gauge the financing structure of the company by comparing its debt over its total assets and EBIT over interest expense.
The most rudimentary equation of accounting tells us assets equal to liability plus equity. Therefore, the first two ratios are basically the same because they both describe the debt proportion in the total assets, which, in more finance aspect, is called gearing ratio. The higher proportion the liability takes up, the riskier the business is, because the liability means the legal obligation of repayment.
Here, we may find that JB Hi-Fi relied more on debt financing than equity: in 2009 the Debt Equity ratio was 1.88 and in 2010 the ratio dropped to 1.43 (the Debt Asset Ratio also fell from 65.30% to 58.90%); in contrast, the Debt Equity ratio in Harvey Norman was around 0.75 in both years (0.775 in 2009 and 0.717 in 2010) and the Debt Asset ratio was around 40%.
Times Interest Earned measured company's capability to cover the interest expense from its operation. It could be found that, although JB Hi-Fi had a higher gearing, it met no problem in covering the liability when its Times Interest Earned ratios were 17.86 in 2009 and 25.38 in 2010. In terms of Harvey Norman, despite of lower gearing, its ratios were lower than JB Hi-Fi (11.03 in 2009 and 12.48 in 2010, respectively).
Overall, JB Hi-Fi used higher gearing than Harvey Norman, but no long term liquidity issue can be identified in its business.
Additional information
There is another two crucial ratios that should be taken into consideration
Earnings per share (EPS)
EPS is also frequently used by stock investor and more valuable to them because it is the portion of a company's profit allocated to each outstanding share of common stock and hence it directly relates to the value of the stock investors own (O'Shaughnessy 2005).
| | JB Hi-Fi Ltd (Consolidated) for years ended 30 June | Harvey Norman Holdings Ltd. (Consolidated) for years ended 30 June | ||
| | 2009 | 2010 | 2009 | 2010 |
| EPS (Diluted) | 87.63 | 108.42 | 20.18 | 21.78 |
Evidently, JB Hi-Fi had a much higher EPS and it was still increasing quickly (about 24%). During fiscal year 2010, every issued share can be allocated more than 1 dollar net profit, whereas Harvey Norman's investors can only be allocated 22 cents net profit for each share they own. Such difference implies that stock of JB Hi-Fi can be potentially of higher returns.
Price-earnings ratio (P/E ratio)
It compares the market value per share with the EPS and is regarded as the description of investors' expectation of the company's growth (Brealey, Myers & Marcus 2009).
| | JB Hi-Fi Ltd (Consolidated) for years ended 30 June | Harvey Norman Holdings Ltd. (Consolidated) for years ended 30 June | ||
| | 2009 | 2010 | 2009 | 2010 |
| Price-earnings ratio | 17.45 | 17.38 | 16.40 | 15.15 |
Both companies shared similar P/E ratios and both witness a little dip in 2010. It means that investors gave higher expectation on JB Hi-Fi's future performance. Moreover, as the difference is not significant, neither of the two stocks was markedly under- or over-priced.
Limitation
The ratio analysis conducted has the following major limitations:
The first limitation of ratio analysis is over simplification. It can be discerned from the above that the ratio analysis only considers most general figures in the financial report and ignores most of the details and all the off-report information, such as future business prospective and competence of management. Moreover, it also ignores the absolute numbers and scales of companies. Such drawback can be covered by combing ratio with other analysis such as data envelopment analysis, market analysis and so on (Athanassopoulos and Ballantine 1995).
The second limitation exists for all the analysis based on financial information. According to efficient market hypothesis (EMH), the current stock price already comprises all the public information in the semi-strong form efficient market. All the financial data including those used in ratio analysis is already available to public through the financial report, thus such analysis with such data cannot bring any extra profit (Patton 1982).
Conclusion and recommendation
Through the analysis, a series of differences have been identified between the two companies with similar business.
As to JB Hi-Fi, its retailing business was more profitable than Harvey Norman's counterpart, its efficiency in using assets and equity was higher than Harvey Norman and so was its cash flow generation efficiency. As to financing structure and stability, JB Hi-Fi relied more on debts but had no liquidity issue in either short- or long-term.
In terms of Harvey Norman, its franchising business ensured a higher and, probably, more stable profitability, but the retailing proprietary business was obviously worse than JB Hi-Fi. Its efficiency in exploiting assets and equity was lower and it could not generate cash inflows from business as quick as JB Hi-Fi. As to financing aspect, Harvey Norman had stronger equity base, which was supported by huge retained earnings.
Overall, it can be found that JB Hi-Fi was more profitable and more robust, while Harvey Norman was more stable thanks to the franchising business. Hence, the recommendation is that investing in JB Hi-Fi when the economy trend is positive, because its retailing development needs to rely on the overall business condition and positive overall trend can enlarge its advantage in retailing profitability and efficiency, and investing in Harvey Norman when the economy trend is negative given its stability in both business and financing structure.
List of references
Athanassopoulos, A. & Ballantine, J. 1995, Ratio and Frontier Analysis for Assessing Corporate Performance: Evidence from the Grocery Industry in the UK. The Journal of the Operational Research Society, Apr., 1995, Vol.46(4).
Brealey, A., Myers, S. & Marcus, A. 2009, Fundamentals of Corporate Finance. New York: McGraw-Hill Irving.
Harvey Norman Holdings Limited 2010, Annual Report. Retrieved from http://www.jbhifi.com.au/corporate/reports/
Horrigan, J. 1978, Financial ratio analysis : an historical perspective. New York : Arno Press.
JB Hi-Fi Limited. 2010, Annual Report. Retrieved from http://www.harveynormanholdings.com.au/
Mowen, M. M., Hansen, D. R., Mitchell, G., & Tibbits, G. 2007, Management Accounting. Thomson.
Patton, J. 1982, Ratio Analysis and Efficient Markets in Introductory Financial Accounting. The Accounting Review, Jul., 1982, Vol.57(3)
The Australian 2010, Electronics retailers impress consumers. Retrieved from http://www.theaustralian.com.au/news/breaking-news/electronics-retailers-impress-consumers/story-fn3dxiwe-1225833121343
Posts
No comments:
Post a Comment