Case Study - Harvey Norman

Key Points:

1. Market leader in the electrical and furniture retailing in Australia & NZ with total sale over 5bn (excluding overseas sale $1bn).
2. Strong brand awareness.
3. Unique integrated property, franchising and retailing system, which has proved track record.
4. Gerry Harvey is the founder and the charismatic leader with nearly 30% shareholding. All directors of the company holds nearly 50%.
5. Forecast FY10 EBIT yield around 10% with underlying operating profit near $300m.
6. Potential upside from Ireland business turnaround and further international expansion (test of reinvestment opportunity)
7. Underrepresented by institutions. Only Ausbil Dexia has 6% holding.

Valuation/Financials

1. EBIT/Enterprise Value

FY09 underlying operating profit was $250million. Assuming 30% tax rate and $34million annual interest expense, the underlying EBIT was 250*1.4+34 = 384m.

Net debt = interesting bearing loan 575m – cash 150m = 525m.

At $4 share price, the market cap of HVN is $4.24b and enterprise value is $4.76 and this translates into EBIT yield of 8%.

The company achieved 40% profit increase in the first half. This will increase the EBIT yield to 11% if the business maintain the momentum.

2. Retail + Property sum of parts valuation

Franchise operating margin (before tax) is around 6%, similar to JBH’s margin. $300m franchise operating result in FY09 capitalised at 10% means the business is worth at least $3bn.

NZ generate 650m sales and 44m before tax result (6.7% margin). The business should worth at least $440m.

Property value is $1.8bn (net $1.3bn after subtracting the debt). Therefore the market basically values NZ/Asia and Irish business at zero.

Key Risks

1. Further hiccup in Ireland and other offshore businesses. The risk of reinvestment (mainly offshore market is high). If the management bite the bullet and withdraw, the stock will ex-growth and become a purely yield play albeit with a very good yield.
2. Protracted economic recovery phase and possiblity of double-dip recession – global economy is in the early phase of recovery.
3. Succession. Gerry Harvey aged 70 should still has 10 years to be at the helm.