Will Harvey Norman end up taking out The Good Guys?
With an investment grade balance sheet which includes a funding surplus of $98 million, a net-debt to equity of 21.58%, return on equity (ROE) consistently above 10%, and a forecast for exceptional earning per share (EPS) growth, retail giant Harvey Norman Holdings (ASX: HVN) looks well positioned to succeed in any future bid for consumer electronics chain store The Good Guys.
As well as broadsiding the interest of its nearest rival, JB Hi-Fi (ASX: JBH), Harvey Norman’s tilt at The Good Guys would help to consolidate its 12.5% share of Australia’s domestic appliance market, and with double the market cap, it’s likely to be the stronger of the two likely contenders.
It’s understood that for the 2015 financial year, The Good Guys – half of which is fully owned by chairman Andrew Muir and his family – had an annual turnover of about $2 billion and a network of around 100 stores.
Last year it generated just under $80 million of earnings before interest, tax, depreciation and amortisation (EBITDA), and revenue growth of 2%.
Whether The Good Guys still favours an IPO over a takeover bid remains to be seen. But the company – half of which is owned in joint ventures with the management or other parties – had been positioning itself for an eventual IPO for some time.
Assuming it does opt for an IPO; The Good Guys is aiming to lift earnings by between 18% and 29% in its first year as a public company. It also expects to earn around $85 million before interest, tax, depreciation and amortisation on a proforma basis in the 12 months ending June 30 2016, and is forecasting EBITDA of between $100 million and $110 million in 2017.
Based on forecast EBITDA of between $100 million and $110 million, the company could have an enterprise value between $800 million and $900 million.
However, these forecasts/valuations would be based on the entire company being under one centralised management structure, unlike the current arrangement where 56 of the 100 stores are joint ventures between the Muir family’s private company, Muir Electrical Company Pty Ltd, and individual store managers.
While it’s understood Muir is planning to buy back full control of the 56 joint venture stores, this could change if strong interest from trade buyers actually eventuates into formal bids.
Interestingly, while Muir has appointed Credit Suisse, Goldman Sachs and UBS as joint lead managers for an IPO, part of their remit is to keep an eye out for alternate ownership options.
Market whispers also suggest that a trade sale would be favoured by the Muir family as a much cleaner exit than an IPO, especially within the current market where appetite for IPOs has been waning, along with consumer confidence.
While efforts by Muir to ‘shop’ The Good Guys to the market are far from new, what’s put potential would-be bidders off – apart from an initial asking price of around $1.5 billion – is the chain’s complex joint venture set-up, and decentralised buying and merchandising systems.
Given that The Good Guys has been talking about issuing a prospectus by September, the retail giants that have been circling the business have a narrowing window within which to show their hand.
However, confirmed reports that JB Hi-Fi CEO Richard Murray has been in preliminary discussions to buy The Good Guys, suggest that the company could find itself in play sooner rather than later, with Freedom, private equity firms Bain Capital, TPG, KKR, and Steinhoff International likely to join Harvey Norman and JB Hi-Fi in any future bids.
Meantime, Harvey Norman, along with its peers has come under share price pressure due to weak consumer confidence, and the recent Beacon Lighting (ASX: BLX) sell-off on the back of revelations it’s been impacted by a cooling in housing markets in Sydney and Melbourne, probably hasn’t helped.
Having been up-trending since late-October last year, Harvey Norman outperformed by 16.47% the S&P500. Adding to share price momentum was the company’s outstanding 22.7% jump in interim profit to $170.7 million, excluding property revaluations.
Contributing favourably to this outcome was the demise of Dick Smith which boosted the company in January and February.
Equally attractive to investors is the Harvey Norman business model – which has always been more than just retail – with more than half of its assets made up of commercial real estate valued at $2.3 billion.
While Harvey Norman’s acquisition in a stake in land and farm assets, including dairy operations last year was a significant divergence from the group’s core business, it’s now seen as having significant upside.
Assuming its re-elected, the government’s decision to raise the tax bracket for middle-income earners from $80,000 to $87,000, should impact favourably on Harvey Norman and its peers, like JB Hi-Fi, with the extension of concessions to companies earning less than $10 million, up from the current $2 million threshold –likely to be an added kicker.
But unlike its peers, Harvey Norman’s extensive product offering means it’s better positioned to benefit from any further tail in Australia’s housing market boom.
What’s also likely to boost its full year result is an expected decline in the Australian dollar over the next few months.
Based on 2016 price to earnings (P/E) multiple of around 18.6x, and a 26% premium to its intrinsic value, Harvey Norman does appear to be fully priced at current levels, and at $4.55, remains relatively close to a higher-end 12 month target price of $5.10.
With earnings expected to grow at nearly 11% per annum for the next couple of years, and a dividend yield; which is expected to grow from 5.13% in 2016 to 54.38%, and 5.72% in 2017 and 2018 respectively, the stock remains a valuable inclusion to any share portfolio.
Buy on dips, and watch closely for a pending bidding war on The good Guys.