Investment Analysis Report

Introduction

Harvey Norman and JB Hi-Fi are two of the best performance listed Australian companies in consumer discretionary retailing industry. This report aims to find the better target for AU$1 million investment between the two alternatives by comparing their past performance and analyzing the risk and return of the investments over the next five to ten years. Various methods have been used for analyses, including EPS and PE ratio, risk and return analysis, share valuation and net present value.

Industry overview

Australia has a highly developed consumer electronics market. This market is expected for a profit of AU$15 billion in Australia during 2011. Apart from continuing introduction of new digital products such as LED TVs and smart phones, individual income increase and the government policies like the National Broadband Network (NBN) will also increase the demand on consumer electronics in the next 10 years.

Company Profile

Harvey Norman (ASX code: HVN) is the largest Australian retailer of electronics products and furniture, which operates over 260 franchise stores with sales revenue of $5.2 billion in 2010. Harvey Norman is considered as the benchmark of the industry focusing on the sustainable growth and aiming to provide outstanding services to high level customers. Harvey Norman has market capital value of $2.8 billion at the closing price $2.64 on 6th May, 2011.

JB Hi-Fi (ASX code: JBH) is the third largest retailer of electronic products in Australia. It had significant growth in last few years and planned to increase its net profit by 25.6% to $118 million in 2011 and open 15 stores every year in the next five years. Compared with Harvey Norman, JB Hi-Fi has established a national online shopping network to gain more market share because consumers are moving to online retailing to buy hi-technology products. The current market capital value of JB Hi-Fi is $2.1 billion at the closing price $19.17 on 6th May, 2011.

Economic environment

The world economy is expected to continue to recovery from financial crisis with a growth rate about 5% annually. Some evidence show likelihood of a new global recession is reducing in the next 10 years. Australian economy shows a stronger growth and is expected to continue leading the global recovery with an annual GDP growth rate of 3.5% in the next decade which is largely due to the strong domestic consumption and the export demand from china and other Asian markets (IMF, 2010).

EPS and PE analysis

As shown in the share price chart in Appendix A, JB Hi-Fi's share increased 785.9% since its first trading in ASX in Oct 2003. On the contrary, Harvey Norman's share has dropped 14.5% during the same period. JB Hi-Fi's outstanding market performance can be explained by its 577% EPS growth in the last 7 years while Harvey Norman's EPS has only increased 36% (see Appendix B). EPS is a good indicator to predict the share prices in the future.

Table: performance estimation of HVN and JBH for 2011-2015

Estimation JBH HVN

Year 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015

EPS 132 153 172 188 199 26 32 34 35 34

Source: http://www.aspectfinancial.com.au.simsrad.net.ocs.mq.edu.au/af/sectoranalys=2&xsl-gicscode=25

From the above table of EPS estimation, JB Hi-Fi' EPS growth rate will be higher than Harvey Norman due to its higher earnings growth. PE ratio comparison can prove the results from EPS analysis. Harvey Norman's PE ratio has dropped from 16.94 to 12.12 and JB Hi-Fi's PE ratio increased from 14.4 to 17.6. Higher PE ratio shows that investors have more confidence in JB Hi-Fi's future performance (see Appendix B).

Return and risk analysis

The total return includes the capital gain and dividend received during the period. The value of $100 invested in JB Hi-Fi and Harvey Norman seven years ago are $1,108 and $203 respectively now. From return analysis of the two companies (see Appendix C), the average returns and the variances are calculated as below:

Table: the average returns and variances

Average return Variance Standard deviation

Harvey Norman 10% 0.10323 0.321295

JB Hi-Fi 39% 0.14078 0.37521

The average returns and standard deviation show that JB Hi-Fi's return is almost three times higher than Harvey Norman with a slightly higher risk.

NPV analysis

Another method can be used is the comparison of the present value of all expected net cash flows discounted by a required rate of return rate which reflects the risk of these cash flows. The expected cash flows of the two companies can be estimated by analysing dividend policy and predicting the estimate future earning of both companies. As shown in Appendix D, Harvey Norman's dividend payments have average growth about 10% per year. It is more likely that Harvey Norman will keep this strategy in the future. On the other hand, JB Hi-Fi's dividends had a