Friday, December 30, 2011

The forthcoming irrelevance of the Australian consumer electronics retailers

This is a post aimed squarely at my hedge fund manager readers who regularly ask me what to short in Australia. The most obvious target (in my view) is retailers - and as a taster I start with the big-box consumer electronics retailers.

Australia still has two electronics chains doing big-box consumer electronics. These are JB HiFi which is well run, has a modern format, a short history and not much balance sheet and Harvey Norman which is a little more old fashioned (like Circuit City in the 1990s it still sells fridges on prime real estate) but has a better balance sheet (reflecting its once glorious history). Harvey Norman also has a franchise model - it does not own all of its stores.

In the US the debate is whether the country can support one or zero highly profitable big box chains. Best Buy - the bears argue - is the showroom for Amazon. In Australia as I said we still have two chains - its as if Circuit City were still around. Moreover because Harvey Norman has a balance sheet it can survive quite a long time and Gerry Harvey is prone to say it is the competitor that will go out of business. But Harvey Norman really is losing share to JB Hi Fi and ultimately both will lose share to the internet.

Gerry Harvey sounds somewhat desperate these days - firstly arguing that internet shopping is a con (nobody makes any money in it) and then arguing that there should be additional taxes on it. Then he sets up an internet company in Ireland.  It looks really bad except that because of the above-mentioned balance sheet he can stay around for a while and he might even be able to liquidate and be left with something valuable at the end. (I still believe liquidating a large retailer is scary-hard.)

The JB HiFi model

JB HiFi spends a lot of money to look cheap. Have a look at their website - it is almost a parody of old-style discounting pamphlets. The stores have false plywood floors to make them look like a discounting house. They have young staff wearing casual clothes and signs that are carefully printed on a computer so that they look hand-drawn. The shop is deliberately cluttered giving it a feeling of being (very) crowded. They don't do products that are not hip. There are no fridges, blenders, toasters but lots of pads, laptops, large screen TVs and computer games. The Apple products are given prime place not because selling them is profitable but because it makes the store look cool.

And for a long time JB HiFi really were cheap. The website flashes the slogan "cheapest prices - always". This was a company with the virtuous cycle of looking cheap and being cheap, selling fast, having high turnover and low inventory costs (important in electronics where obsolescence is quick) and just looking like a happening place. It was also a hot stock.

But it does not ring true any more. They are not the "cheapest prices always" - far from it. They match prices on large items where people price check and they will match prices if you really push them (trade practices law in Australia makes it hard to advertise the cheapest price if you don't have it) but I am noticing that on "convenience items" such as cables and SD cards they are pricing aggressively high. They spend money to look cheap but they aren't any more. It is the advertising tag-line of a decaying business.

They missed earnings expectations a while ago - the stock is having a rough time. But it is still fairly richly valued (do comparisons of price to sales if you want). The immediate question is how far further will it go and will Gerry Harvey keep throwing his good balance sheet at staying in the game and give them pricing pressure. Gerry Harvey it seems wants to be the survivor.

My Christmas Observation

I purchased a camcorder at Christmas and forgot to buy an SD card. These produce a lot of data so a big (ie 32gb) card was required.

Here is the only such card at the JB Hi Fi in the major shopping mall in Bondi Junction.



You see that price right: $299. It is the 45 mb/s version.

Here is the same product via an Amazon partner store at $128.

Gerry Harvey doesn't do better. Here is a 32 gb card at the Harvey Norman in the same shopping centre.


 The product is a Sandisk "ultra" at $190. Amazon will sell you an identical product for $39.

I am trying to work out the dynamics of this with regard to the stock. My best model is the decline of Radio Shack which did this before them. Radio Shack had a business model built on squeezing very fat margins out of customers that needed something now. They had 2400 stores over America so they were close enough to anyone who needed them pronto.

And proximity was useful. Remember the days you absolutely needed that Firewire cable and were prepared to drive to the local Radio Shack (or Dick Smith in Australia) and pay $10-20 for something that would cost 50c to purchase in China? As the Onion observed we do not need so many cables any more and Radio Shack has become irrelevant. These days it survives by selling mobile phone contracts.

Well as my little SD card survey demonstrates the big-box electronics stores here have become Radioshack - albeit with a bigger footprint and the pretence of "lowest prices". But Radioshack didn't blow up - it just sort of drifted away. The stock was $70 in 2000 - the peak year in which everyone was connecting their computers to the net and needed all those cables. It is $9 now.

That I think is the future here too. The two stores won't deal either one a death-blow. Gerry Harvey will continue to lose share to JB Hi Fi (who look cheaper and cooler) but he and his company are rich and they can bleed for a very long time. JB Hi Fi will continue to charge "convenience prices" to the customers hiding behind their faux-cheap facade.

And we will wake up in a decade and realize these companies are just not important - or for that matter even relevant.



John

Disclosure: no position in the funds. For various tax reasons we have elected to have no Australian positions.

37 comments:

Anonymous said...

I'm not sure why you went to JB or Harvey Norman when you could have gone to msy in the city and paid half price.

Ronald Brak said...

What surprised me recently is that Dick Smith now appears to be selling things that people might actually want to buy at prices that actually seem reasonable. This surprised me.

Poking around on the internet (carefully, because sometimes the internet pokes back) I found they are also selling stuff online. I would guess that they are trying to be both the display room where one checks out the stuff and the online store where one actually buys it.

I'm afraid that with my $50 a month internet connection their site is too slow to use without frustration. But's that's not their fault, after all we don't have South Korea's internet speeds. In fact, Australia doesn't even have Slovenia or Ghana's internet speeds. But as soon as the internet speeds up a little, and I get a job, I will check out their site for something to buy. I don't know what though. I thought I might buy a TV, but TVs are for old people.

Oliver Townshend said...

I don't think Dick Smith Electronics is immune from this trend. Granted they have Woolworths behind them, but I think most consumers prefer JB Hifi to DSE. And Woolworths may have a great balance sheet, but they will cut a line they don't think is profitable.

Anonymous said...

John,

A notably interesting (and relevant) point about the card at JB is that they are actually selling obsolete stock.

If you look over the Amazon link you posted, it states that the card has been superseded and links to the new model.

What that means is that when JB fails to sell their overpriced card (for which they undoubtedly paid a premium price to put on the shelf), they will be left with a massive writedown. How many other items on their shelves are like this?

SB

James Benter said...

Err hang on a minute: Harvey Norman is a general household retailer. Electronics, furniture, interior fittings the lot. Its not going anywhere. TVs will die, washing machines and carpet won't.

Err hang on a minute: Bing-lee; Good guys; DSE; Middas, Retra-Vision all are stand alone electronic chain store competitors. JB will be left after others fall. Still cheaper. JB won't be going anywhere for a long time.

Analysis a little wide of them mark. Not a bad crack though. Shouldn't paint with broad brushes.

Ben said...

I know JB is a very hard borrow (and I'm guessing the other one is too), so this may not help your hedge fund friends much. But appreciate the article.

John Hempton said...

Fair comment on Bing Lee (who are still private). Not so fair on Gerry Harvey. His problems are consumer electronics and the general household stuff ain't gonna be much fun when Australia has its housing downturn. As a trading omission that is not too bad.

And yes - sorry I was painting with broad brushes. Can't do much more in 1000 words.

There are also deep disocunters like the Good Guys. Different floorspace model that.

J

Anonymous said...

John,

I have thought about this topic for a long time, and while I think you are broadly correct I wonder if you could shed more light on 'why'.

I have two point to add.

1. JB Hifi does have a relatively strong balance sheet, but I do not think that the franchisees necessarily do. It is impossible to verify, but many of them would have been caught up in the great Australian dream of owning their own business and leveraged up to buy a slice of heaven. Therefore there will be a limit to the level of discounting that can be undertaken.

2. This next point applies to retail in general.While we pay high prices, doesn't this also reflect our 'high cost economy'. By that I mean labour and payroll taxes, inflexible hiring agreements and most importantly rent.
I can't see Australian retail becoming competitive without attacking the cost structure.
I wonder how the NBN with high speed internet for all will change things.

Anonymous said...

John

I think this is correct and even greater for book stores / dvds.

What effect will this have on employment? I think retail is one of the biggest employers. If retail and housing were to slow I would think Australia would have some big issues.

Anonymous said...

John, Your thesis makes a lot of sense. There is one angle which you might wish to consider further, that is, the effect of warranties and post-sale service. Basically, if you buy some electronic gizmo from an internet store, as a practical matter warranty support is zero or near enough to zero that it doesn't matter. Obviously, that's not relevant when you deal with small-ticket items like cables or SD cards. However, when you look at more sophisticated items, warranty support is available only if the consumer purchases from an 'approved reseller', which has the effect of limiting the attractiveness of parallel imports. Cheers.

Disclosure: I've put some money where my mouth is on the above, but I won't name any names because I'm trying to buy some more.

Anthug said...

yeah even with the shipping amazon is cheaper but they won't necessarily ship everything to australia - john, given all this, what do you think of Westfield?

Anonymous said...

prices are so much more transparent these days with price crawlers and meta search engines.

Anonymous said...

Are you being somewhat facetious about Radio Shack? Cables? They used to be a serious computer manufacturer and hobbyist supplier. That worked when people actually knew about hardware. What I see now in both retail and commercial electronics is people want stuff for nothing, even if it's junk. Support, reliability, assembly quality are nearly worthless. I just don't see a bright future for anyone, including Amazon.
Rich

John Hempton said...

I am not at all being facetious about radio shack.

There were 2400 stores - one within 10 minutes drive of most Americans.

They sold that hobbyist stuff - but there was no way that there were enough hobbyists to keep 2400 stores open. May 240 stores - but not 2400 stores.

The 2400 stores was to sell convenience, not plug adapters to switch 4 pin motherboard power supply into 8 pin motherboard power supply.

John

Anonymous said...

One important thing to consider is what other online retailers besides Amazon pop up "locally", e.g. with more finesse then international delivery can afford. Because one material advantage for "real" stores is the right now effect, and local online retailers with fast deliveries finish that one off.

I honestly have no idea how Australian online retail feels, but if it does, Radioshack might be "the best case".

Tho actually, the difference between properly imploding and slowly fading out to obscurity in brick-mortar retail is really hazy. In no small part it depends on stuff like rent and labor costs, e.g. if it's possible to "clinge to a fringe" near break-even selling "several cell contracts per day".

Then again, there's always a possibility of a good old mess-up on their own part. Drifting away to irrelevance is the default path, but many fading companies tried to pull off something big and breaking through on the way. And more often then not, afterwards, "autopsy revealed that the cause of death was intensive care", so to say.

Regards,
Dmitry.

Anonymous said...

P.s. to discussion in comments

It's not exactly that people want stuff for nothing, it's that that stuff mostly should really cost nothing.

Support, reliability and assembly quality are matters of percentile difference - maybe 10%, maybe 20, mm-kay, 30%.
Not like 300% or what.

Let's be honest - for a long long time a "high-tech manufacturing" was very lucrative business. Yep, huge "fixed" RnD costs, but then you basically sell stuff at hundreds of % mark-up. It keeps going well for few who indeed still do their RnD spendings.

The rest just take some basic/old stuff and somehow imply it should cost proportionally.
I can see buying Intel CPU which costs $1 to make for $300 - they did spent good money upfront to develop it. But why anyone should pay $100 for $0.5 SD card made with most basic designs is quite beyond me.

And it seems to be catching up.

Anonymous said...

You picked the wrong card on Amazon. Here's the correct card, its $128:

http://www.amazon.com/SanDisk-Extreme-Pro-SDHC-SDSDXP1-032G/dp/B004JJQN8G/ref=sr_1_1?ie=UTF8&qid=1325444839&sr=8-1

Anonymous said...

John: Radio Shack absolutely was hobbyists, computers, and stereos in the 70's and 80's, migrating to VCRs, and then DVD players, digital cameras, and home theater stuff in the 90's. Just look at their catalogs. But they expanded into areas that were dying. Yeah, high prices for simple things like memory cards are not helping your RSH equivalents, but there is a bigger problem beyond paying for convenience - the market for the stuff RSH used to sell is gone. Walk through a college dorm and count the stereos. You're lucky if you can find even one.

My point is lower prices will not help RSH and their ilk survive, since the stuff people used to buy via looking, touching, and pushing buttons doesn't sell enough any more. Maybe lower prices would help Best Buy survive a bit longer. My old company could sometimes get overnight delivery from China. I suspect the future is not Amazon but directly ordering from knock-off suppliers in China.
Rich

Anonymous said...

Since no one else has done so, I would be remiss if I did not wish you a happy 2012. I am sure I speak for everyone: Many thanks for spending the time writing this blog that has immensely benefitted all of us readers.
Rich

Anonymous said...

HDMI cables at best buy ($50, $40 on sale) have been keeping them afloat for the past few years.

Never pay more than $5 for an HDMI cable, unless it's over 10 feet long.

Marc Loveridge said...

Great post and summed up well - a slow bleed at the hands of far larger, more efficient internet retailers sounds like the future for HN.

Not so sure about JB though. JB is a music brand - the clue is in the name ; ). Everyone knows that record shops are where the kids hang and JB has done a great job of hooking people in to the brand through CDs then selling them TVs and expensive HDMI cables.

Now that they're CD revenue is under threat from iTunes/Grooveshark/Spotify you don't see JB whinge like Gerry, instead they pivot and bust out their own subscription streaming music service (JBNow).

And you can bet your over-priced SD card that they'll use this music service (which comes with a one month free trial) as a traffic generator for their online store...where they'll sell the kids cut price TVs and gaming consoles.

Anonymous said...

Not to speak for John in reply to Arthug but if you are going to own any large property stock in Australia make it Westfield, the class act in the sector globally and its expansion plans in Brazil and Argentina are very exciting.

If you are going to own a small real estate stock in Australia make it Carindale, eventuially westfield are going to take out the half it doesn't own at valuation and note a recent substantial shareholdingh notice from the Myer familys private company-thery tend to know a bit about retailing...

If you are shorting an AREIT or are thinking about it can I introduce you to an absolute disaster masquerading as a sound business run by an accountant from Yorkshire who has an opinion about absolutely anything but no feel for real estate?

Alex said...

Similar article on Forbes about Best Buy, published on Sunday: http://www.forbes.com/sites/larrydownes/2012/01/02/why-best-buy-is-going-out-of-business-gradually/

Anonymous said...

Your article is such a predictable response to this retail downturn. Everyone can point the finger...oh it's so easy. Look mum..how cheap this stuff is online..but

Couple of quick questions.

1/ Where did you buy the camcorder?
2/ How do you buy your furniture, whitegoods, and do you go into a store and look at a TV before you buy it?
3/Do you like to be covered by Australian consumer protection and warranties? Do you like the idea of sending your goods back to Hong Kong or the US if they aren't what is expected..?
4/ What makes you so sure these retailers can't survive with changes to their business and selling models, like direct online sales from within the shop to stop customer churn? And cost cutting with staff cuts and better inventory management selling online themselves straight from chinese warehouses..
5/ Are you also shorting the Aussie dollar? What if the dollar plunges bak to 60 cents..?What happens to online prices then?
6/ Why pick out HVN and JBH? Surely DSE (WOW) and smaller electrical retailers and the Department stores are likely to suffer loss of market share before these well run companies. Are you predicting these retailers, and other furniture stores will go out of business as well?
7/What stocks do you recommend as an alternative, or do you think ALL mainstream retail is finished..?
8/Why haven't you accounted for actual growth in sales of electrical goods overall, when the economy inevitably picks up? Or don't you think this will ever happen? Or if it does, that HVN and JBH will be out of business before it does...

Anonymous said...

Interesting points. Thanks

Mars said...

When it comes to the ability of local retailers to compete with foreign on-line shops (bricks, on-line or bricks-and-clicks, or whatever), one issue that no one seems to be commenting on is the prices Australia based retailers are paying for their goods from OS suppliers. Their biggest cost, far and away, is not their fixed operating costs, it's their wholesale prices. Look at JB's gross margin, its about 22%. For HVN's owned shops (not franchised ops) it's about 27%. That 22% or 27% has to cover rents, labour etc, and leave a little to shareholders (one hopes!).

Now those margins translate to markups in the range 30% to 40%. Whilst I'm not saying that's insignificant, it's not the crazy markups many consumers would have you believe, when you read/hear the hysterical commentary about stores being “rip off merchants”.

So the elephant in the room has to be the differential pricing still being applied by distributors and suppliers, to Australia, compared with other countries. If that playing field was levelled somewhat, surely the whole question of the survival and competitiveness of local retailers' would have to e re-assessed.

So my question, why are local retailers not making noises about this issue, instead of carrying on about side shows such as the GST on foreign goods?

Anonymous said...

Re Mars: This is indeed something quite interesting, as the world-wide wholesale (and retail) prices are not reflection of what you'd expect given the factory-door prices (and of course including things like transport, localization etc.).
Even in EURoland, where you can shop across the borders, have no FX volatility, most of things are localized etc. the prices (and even availability of models/features) can be widely different between countries, much more so than one would expect. Various pundits have been predicting prices to converge, but it hasn't happened yet, so there must be a story in that somewhere... (and don't get me on US vs Europe prices - again, after taking into account all the bits that are different)

Cliff said...

Interesting ! much is true although I think the true evolutionary path that the internet will take is unknown at this stage.
It is vastly overstated in Australia with e-commerce still less than 5% of total commerce.
You seem to have totally ignored the mass merchants in your summation .
Big W, K-Mart and a few others are now accounting for a decent market share in consumer electronics.
Harvey Norman corporate owns all the stores.
Yes its a franchise but its a $2 share.
The proprietors are nothing more than managers.
The % of the profits they get is getting less and less as the corporate takes back more and more.
The amount of resignations HN is experiencing at the moment is astonishing.
As for JB personally I think the business model is faulty.
They only show a profit when they open new stores.
Currently they are only talking about it.
It seems to me its all been seen before . "BRASHES"

Ronald Brak said...

Does going to a store and looking at a TV do any good these days? In ye olden times one could go to the store and fiddle with the knobs to see how good a picture one could get, but when I went to Dick Smith's the TVs didn't even have knobs on them. So does the picture quality on the display TVs represent the actual quality of the TV, or are the TVs settings adjusted so the ones that bring in the most profit have the best image quality?

the buckaroo said...

hey jh...spot on analysis though not that difficult a call. Amazon usurps sales & lets the brick & mortar outfits take the rent & wages hit, nice business plan when Best Buy, etc. cannot afford to train properly nor pay for the luxury of passionate gearheads.

The accessory niche has been the profit maker since way back when...unless you set up your tent across the avenue from the largest trans-shipper in the local market.

I had such a store in Berkeley with the best spread of video goodies & toys (Sony thru Toshiba & back) & one day it dawned on me...take the video tape (T-120's) market as the loss leader which created the illusion of inexpensive on all levels.

We pounded that message thru ads (sales in case lots Sat-Sun only) until the manufacturers stopped supplying product (tape). So I had the proper response...trans-ship the stuff. The manufacturers finally relented & product flowed.

T120's were 12.99 when I dropped the case lot price to 7.99 each. Sold mountains of the stuff with customers wall-to-wall. Ah, the good old days.

Didn't know the Good Guys were still in existence...started in S.F. on Lombard, btw.

jph

daybillposters said...

Mars: At a Q&A in October last year, I asked Ruslan Kogan (the "Kogan" CEO) the question regarding electrical retailers in Australia and why, say, a Panasonic camera is $200 cheaper at B&H New York even after postage and even after GST considerations. He claimed that the big US/Japanese/Korean electrical companies have different wholesale prices for different regions, and Australia was one of the more expensive. I have no evidence this is true (and he did not explain why this was the case), and one might argue that it only takes several major electrical manufacturer to break-away and provide Australia with cheaper wholesale prices. I am only highlighting what he said without, unfortunately, any evidence it is indeed true.

Another argument in the market place is commercial property prices in Australia, that are much higher elsewhere. In newspaper articles I observed 12/9/10 and 2/9/11, Pitt Street Sydney is now more expensive than Paris and London's High Streets (a Google search on this topic will bring up many articles discussing this topic).

Mars said...

dailyposters: Thanks for that feedback. So my question remains, why is Gerry Harvey (and others) not going on about this issue? I don't get it?

Or for that matter, why don't these retailers source product from countries with lower wholesale prices and sell in Australia? Perhaps that's essentially what is starting to happen (eg with Harveys direct imports from Ireland)?

Mars said...

daybillposters: regarding my reference to 'dailyposters', pardon my dislexia!

Ronald Brak said...

After bad mouthing Australia's internet speeds earlier, I just stopped by to say that my internet speed has picked up considerably over the past couple of days. I don't know why but it might have something to do with people no longer crawling up and down the mobile phone tower across the road. (I think they were crawling all over it to fix it rather than, you know, getting pleasure from it.) But on the off chance that you fixed it, John, thanks.

John Heslop said...

far the best austral;ian online electrical goods retailer is appliancesonline, who have supplied me a stove and barfridge at lowest price, free delivered in 2 days to Newcastle and took away the old appliance free. Harvey, Domayne at al cannot match them for service and price and this is bound to kill bigbox retail soon.

Alex Rose-Innes said...

I see that Woolies are washing their hands of Dick Smith:

http://www.smh.com.au/business/woolies-sales-growth-falls-short-of-targets-20120131-1qqdd.html

Ross Taylor said...

Excellent article and well described. A slowly hemorrhage at the arms of far bigger, more effective internet providers appears to be like the future for HN. When it comes to the capability of local providers to contest with international online stores, one issue that no one seems to be leaving comments on is the costs Australian based providers are paying for their products from OS providers. Their greatest cost, far and away, is not their set managing costs, it's their general costs. Look at JB's total margin, its about 22%. For HVN's possessed stores it's about 27%. That 22% or 27% has to cover leases, labor etc, and keep a little to investors. Country Overview

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