Harvey Norman (ASX:HVN)

Kay Lesley Page
CEO
Market Cap (AUD): 5.32B
Sector: Consumer Discretionary
Last Trade (AUD): 4.31 +0.04 (+0.94%)
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1. About

Harvey Norman Holdings Limited (ASX:HVN) principal activities primarily consist of an integrated retail, franchise, property and digital enterprise.

Australian Franchise System

Harvey Norman® operates under a franchise system in Australia and consistently delivers an unparalleled retail offering to Australian consumers with an extensive product range, cutting-edge technology and market leadership in key product categories.  Harvey Norman Holdings Limited grants franchises to independent proprietors under three leading brand names: Harvey Norman®, Domayne® and Joyce Mayne®.  The proprietors sell products in the following categories: electrical goods, furniture, computerised communications, bedding and manchester, kitchen appliances, small appliances, bathroom and tiles, carpets and flooring.

Harvey Norman

The Harvey Norman® brand name is a retail icon throughout Australia with 57 franchised complexes in New South Wales, 1 in the Australian Capital Territory, 37 in Queensland, 38 in Victoria, 17 in Western Australia, 10 in South Australia, 6 in Tasmania and 2 in the Northern Territory. Brands sold across the 168 Harvey Norman® franchised complexes throughout Australia are market leaders in the core audio visual and technology segment.

Domayne

The Domayne® brand name was launched in May 1999 and currently has 12 franchised complexes in New South Wales, 1 in the Australian Capital Territory, 3 in Queensland and 2 in Victoria.  Domayne® franchised complexes offer a contemporary range of furniture, bedding, computer and electrical products.

Joyce Mayne

The Joyce Mayne® brand name was acquired in July 1998 with 7 stores of which 6 were converted to Domayne® franchised complexes in May 1999.  As at 30 June 2016, there were 6 Joyce Mayne franchised complexes, 2 in New South Wales and 4 in Queensland.

2. Business model

 

The Group operates in following divisions:[1]

 

Divisions

Revenue ($’000)

% of Revenue

% of Profit (before Tax)

Profit drivers[2]

Franchising Operations

$932,669

28.8%

53.3%

  • The franchising operations segment result decreased by $21.99 M, or 7.2%, to $282.54 M in the 2018 financial year from $304.53 M in the previous year. This was a solid result particularly as it was on the back of a strong 13.6% growth in the 2017 financial year and the massive 34% increase in the 2016 financial year. The result generated by the franchising operations segment represented 53% of the total consolidated profit before tax result for the 2018 financial year
  • Revenue in this segment reduced by $7.64 M, or 0.8%, to $932.67 M primarily due to a decrease in franchise fee income of 1.8%, or $14.41 M, to $768.45 M in the 2018 financial year from $782.86 M in the previous year. Tactical support payments to protect, enhance and promote the brand increased by $10.50 M, or 16.3%, to $74.98 M for the year ended 30 June 2018, up from $64.48 M in the previous year

Total Retail

$2,033,569

62.9%

19.8%

  • Total aggregated company-operated retail sales revenue is almost at the $2 B milestone for the 2018 financial year, the strongest-ever sales performance for the retail segment, growing by $157.72 M, or 8.6%, to $1.99 B relative to $1.83 B in the previous year
  • Retail sales for the 39 Harvey Norman® stores in New Zealand alone have almost reached $1 B in local currency, whilst sales in Asia are nearly at $0.500 B for the 2018 financial year. Total company-operated revenue broke the $2 B barrier in the 2018 financial year hitting $2.03 B for the year, an increase of $158.53 M, or 8.5%, in aggregate relative to $1.88 B in the 2017 financial year
  • The result before tax for the company-operated retail segment increased $14.11 M, or 15.5%, to $104.96 M for the year ended 30 June 2018, from $90.85 M in the 2017 financial year

Total Property

$304,615

9.4%

35.6%

  • As at 30 June 2018, total property assets amounted to over 62% of the consolidated entity’s total asset base of $4.58 B. Growth in the property portfolio was mainly due to the continued solid market conditions in the large-format retail sector delivering capital appreciation during the year
  • Total assets increased by 9.3%, or $387.90 M, to $4.58 B as at 30 June 2018, from $4.19 B in the previous year. The value of the investment property portfolio increased by $187.64 M, or 8.4%, to $2.43 B as at 30 June 2018 primarily due to the net property revaluation increment of $51.65 M during the current year and the acquisition of other investment property assets during the current year

Equity Investments

$6,154

0.2%

1.1%

  • Cash and cash equivalents increased by $90.32 M relative to prior year, with substantial growth in net cash flows from operating activities by $29.03 M, or 6.8%, to $454.17 M for the year ended 30 June 2018. This was primarily achieved by an increase in net receipts from franchisees by $64.58 M, or 7.3%, to $947.06 M during the year
  • The consolidated entity’s operating cash conversion ratio, calculated as operating cash flows before net interest and tax paid as a proportion of EBITDIA (excluding property revaluations), is strong with an operating cash conversion rate of 97.6% for the 2018 financial year, an increase of 720 basis points on the cash conversion rate of 90.4% for the 2017 financial year

Other

$18,085

0.6%

(9.8%)

  • The Other segment recorded a loss of $51.78 M for the year ended 30 June 2018 compared to a loss of $9.12 M for the year ended 30 June 2017, a deterioration in the losses incurred by $42.66 M
  • The Coomboona JV commenced trading in September 2015 and the equity-accounted trading losses were $4.57 M for the year ended 30 June 2018 compared to equity-accounted trading losses of $5.95 M for the prior year
  • Combined, the Coomboona JV equity-accounted trading losses of $4.57 M, the impairment of the Coomboona JV investment in
    December 2017 of $20.67 M and the estimated impairment loss for the shortfall in the recoverability of funds advanced by NCF and the
    HN JV Entity of $28.78 M, totalled $54.01 M and was recognised as losses in the income statement for the 2018 financial year

Intercompany Eliminations

($60,629)

(1.9%)

N/A

N/A

3. Strategy

 

O2O STRATEGY The Online-to-Offline (O2O) Strategy of Harvey Norman®, Domayne®, and Joyce Mayne® franchisees continues to develop and enhance the service offering to their customers. The O2O Strategy is well positioned to mitigate any potential disruptions and has been further enhanced over the 2018 financial year. Franchisees are committed to delivering a seamless experience to their customers with the introduction, upgrade or enhancement of the following initiatives:[3]

  • LivePerson – LivePerson is a digital service platform that gives customers the ability to communicate with Harvey Norman® under whichever channel they desire, whether that be email, SMS, Apple Business Chat, WhatsApp, Facebook Messenger or Livechat. This platform also facilitates after hours and augmented customer support during peak trading periods to respond to commonly asked questions and queries using AI conversational bots. LivePerson brings together the AI and automations necessary to provide a great customer experience across multiple touch points at scale, along with services such as order status updates and reservation changes. These services allow customers of Harvey Norman® franchisees to message in the same “time-shifted” way they message friends and family, moving in and out of conversations to multi-task or go on about their day. Push notifications and history allow the consumer to continue on their own time.
  • Near Real-Time Inventory – Providing customers with accurate and up-to-date stock information confirming their local franchisee has the product they are interested in purchasing.
  • Quick Reserve – Allowing customers to quickly reserve a product and know that product will be available when they arrive at their franchised complex.
  • 2-Hour Click and Collect – At the heart of the Harvey Norman O2O strategy, Click & Collect is a convenient and popular way to shop with over 80% of customer’s orders notified in under 2 hours.
  • Improved Expert Reviews – Franchisees have access to reports that provide unbiased editorial content and ratings on products, specifications, and user reviews to aid the customer in their selection process.
  • Improved Site Search – The Harvey Norman® online self-learning search algorithm provides customers with the most relevant and suitable product to assist the search process.
  • Furniture Collections – Enhancing the Harvey Norman® online Furniture pages to include collections to provide customers an enhanced online experience.

 

Supporting the O2O strategy, several Customer Service initiatives were also introduced, upgraded or enhanced during the 2018 financial year including the following:

  • Harvey Norman® Voice continues to grow and resonates strongly with customers. This digital platform was created to provide enhanced one-on-one engagement with a cross-section of Harvey Norman® customers to obtain feedback prior to changing processes or investing in system enhancements. Listening to customers is central to the Customer First mindset.
  • Mobile First – As one of the first retailers in Australia to launch PWA (Progressive Web App) Harvey Norman® franchisees are utilising this cutting-edge technology to optimise the customer experience on mobile to engage and inspire customers and drive franchisee sales growth.
  • Store Location Management System - Provides a single source of truth across all information services for franchised complexes including location information, contact details, trading hours, and local events, allowing customers to easily obtain information about their nearest Harvey Norman® franchised complex.

4. Markets

 

The Group operates in the following industries:[4]

 

Industry (Australia)

Industry Revenue (2018)

Growth Rate (annual 13-18)

Franchising

$177 billion

1.7%

Domestic Appliance Retailing

$15 billion

2.1% (Annual 14-19)

Computer and Software Retailing

$6 billion

2.6% (Annual 14-19)

Furniture Retailing

$7 billion

1.0%

5. Competition

 

Major competitors Include:[5]

 

  • Woolworths Limited (ASX:WOW)
  • David Jones Pty Ltd (ASX:DJS)
  • Myer Holdings Ltd (ASX:MYR)

6. History

 

1982[6]   

Harvey Norman was established in October 1982 by Gerry Harvey and Ian Norman

 

1987   

Harvey Norman had gone public on the Australian Stock Exchange

 

1991   

Harvey Norman launched a computer superstore

 

1997   

The Company opened its first store in New Zealand

 

1998   

The Joyce Mayne furniture and appliance chain and Archie Martin Vox stores were acquired

 

1999   

The retail chain Domayne was launched

 

2001   

Harvey Norman opened the first signature store in Millenia Walk shopping centre, Singapore

 

2002   

The Company's first store in Slovenia opened

 

2003   

The first store was opened in Dublin, Ireland

 

2007  

Sold Controlling Interest in Rebel Sport Limited

 

2011   

The Norman Ross brand was launched in the New Zealand market

 

2014   

Compulsory Acquisition of Shares in Pertama Holdings Ltd

 

2015   

Harvey Norman Holdings Ltd acquired significant stake in Coomboona Holdings Pty Limited

 

2017   

Agreement signed with Harvey Norman Commercial Div-NSW

 

2018   

Renounced Pro Rata HVN Entitlement Offer Info Booklet

7. Team

 

Board of Directors[7]

 

Gerald Harvey – Chairman

Katie Page – Executive Director and Chief Executive Officer

Chris Mentis – Executive Director, CFO and Company Secretary

John Slack-Smith – Executive Director and COO

David Ackery – Executive Director

Michael John Harvey – Non-Executive Director

Christopher Brown – Non-Executive Director

John Craven – Non-Executive Director

Graham Charles Paton – Non-Executive Director

Ken Gunderson-Briggs – Non-Executive Director (Independent)

 

Management Team

 

Martin Anderson – General Manager (Advertising)

Thomas James Scott – General Manager (Property)

Gordon Ian Dingwall – Chief Information Officer

Lachlan Roach – General Manager – Home Appliances

Ajay Calpakam – General Manager (Audio Visual)

Frank Robinson - General Manager – Technology & Entertainment


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8. Financials

 

2018 Full Year Results Presentation

 

Financial Year 2017/18 (ended 30 June):[8]

 

Divisions

Revenue ($’000)

% Change

Profit (before Tax) ($’000)

% Change

Franchising Operations

$932,669

(0.8%)

$282,540

(7.2%)

Total Retail

$2,033,569

8.5%

$104,960

15.5%

Total Property

$304,615

(14.8%)

$188,568

(23.8%)

Equity Investments

$6,154

(3.4%)

$5,884

(3.2%)

Other

$18,085

5.5%

($51,780)

(467.7%)

Intercompany Eliminations

($60,629)

(4.5%)

N/A

N/A

Total

$3,234,463

3.1%

$530,172

(17.1%)

9. Risk

 

Major risks include:[9]

 

Business Risk

 

Deterioration in macroeconomic conditions resulting in a fall in consumer sentiment:

The consolidated entity has a significant exposure to the economy of the countries in which it operates. There are a number of general economic conditions, including interest and exchange rate movements, overall levels of demand, housing market dynamics, economic and political instability and government fiscal, monetary and regulatory policies, that can impact the level of consumer confidence and discretionary retail spending, thereby affecting revenue from sales to customers and franchise fees. The consolidated entity seeks to reduce its exposure to these risks by closely monitoring both internal and external sources of information that provide insights into any changes in demand within the economies in which it operates.

 

Competition resulting in a loss of market share for franchisees in Australia:

The integrated retail, franchise, property and digital system, and diverse category mix aid in maintaining the consolidated entitys competitive position. Franchisees operate across a number of categories including the strongly performing Home and Lifestyle market. Diversity mitigates the risk from existing and potential single-category competitors.

 

Emergence of competitors in new channels:

The Harvey Norman Omni Channel Strategy provides customers of franchisees with a diverse, consistent and distinctive Harvey Norman  customer experience through a diversity of channels. The Harvey Norman Omni Channel Strategy integrates retail, online, mobile, and social channels. The online operations of franchisees in Australia and the company-operated online operations in New Zealand have grown substantially. The digital platform creates new opportunities for growth and new ways to embrace and engage with customers. Data analytics are an important element of the Harvey Norman® Omni Channel Strategy, and are utilised to improve customer experience. The Harvey Norman® Omni Channel Strategy sets the Harvey Norman® brand apart from other online and digital competitors as the digital, physical complex and distribution channels are fully integrated, providing customers of franchisees with a multitude of engagement options to meet their needs. The Harvey Norman® Omni Channel Strategy, supported by the retail property portfolio of the consolidated entity, makes the Harvey Norman® brand a strong competitor in the market.

 

Economic downturn in the property sector leading to softening property asset values, falling market rentals and reduction of future capital returns on property assets:

With a property portfolio of $2.66 billion, the consolidated entity is exposed to potential reductions in property values within the bulky goods sector. The consolidated entity has a selective and prudent acquisition and development strategy and maintains high-quality complexes and a solid, dynamic, complementary tenancy mix in order to maximise the profitability of the property segment.

 

Counterparty risks of service providers:

This risk relates to the inability of service providers to meet their obligations. The consolidated entity closely monitors and evaluates the performance of external service providers to mitigate counterparty risk.

 

Counterparty risk associated with the mining camp accommodation joint ventures:

Commodity prices are inherently volatile. The provision of services to the mining industry is inherently risky. The consolidated entity has entered into joint ventures with counterparties to provide mining camp accommodation services. The risk in respect of mining camp accommodation joint ventures includes the ability of counterparties to meet financial and other obligations under mining camp accommodation joint venture agreements. The consolidated entity closely monitors and evaluates the performance of counterparties of the mining camp accommodation joint ventures by monitoring compliance with joint venture agreements; adopting a prudent and conservative approach to the review of mining camp accommodation cash flows, including future cash flow projections; and ensuring that an adequate level of security is maintained for any funds advanced to mining camp accommodation joint ventures.

 

Compliance by franchisees with franchise agreements:

This risk relates to franchisees not operating their assigned franchise in accordance with the terms and conditions of their respective franchise agreements. The consequences of non-compliance may include damage to the brand, fines or other sanctions from regulators, and/or a reduction in franchise fees received from franchisees. The franchisor continually monitors and evaluates the financial and operating performance of each franchisee to actively assess compliance with executed franchise agreements. Instances of noncompliance are promptly addressed to protect the Harvey Norman brand and/or intellectual property of the franchisor.

 

Information Technology (“IT”) security and data security breaches:

This risk relates to potential failure in the IT security measures resulting in the loss, destruction or theft of customer, supplier, financial or other commercially-sensitive information including intellectual property. This has the potential to adversely affect the company’s operating results which would lead to lawsuits, damage the reputation of the Harvey Norman brand, and/or create other liabilities for the consolidated entity. There are a number of key controls either planned or already in place, including an ongoing program of investment in cyber security software; the implementation, maintenance and supervision of operational policies intended to preserve the confidentiality and integrity of IT systems; regular independent audit and review of IT security; and the ongoing review, practise and updating of a disaster/crisis management plan relating to IT systems.

 

Financial Risk

The consolidated entity's principal financial liabilities, other than derivatives, comprise of trade and other payables and loans and borrowings. The consolidated entity's principal financial assets, other than derivatives, include trade and other receivables, shares held for trading and listed shares available for sale.

 

Market Risk

Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices.

 

Foreign Currency Risk

Foreign currency risk refers to the risk that the value of financial instruments, recognised asset or liability will fluctuate due to changes in foreign currency rates. The consolidated entity undertakes certain transactions denominated in foreign currencies, hence exposures to exchange rate fluctuations arise.

The consolidated entity's foreign currency exchange risk arises primarily from:  

  • Receivables or payables denominated in foreign currencies  
  • Firm commitments or highly probable forecast transactions for payments settled in foreign currencies

The consolidated entity is exposed to foreign exchange risk from various currency exposures, primarily with respect to:  

  • United States dollars  
  • New Zealand dollars
  • Euro  
  • British pound  
  • Singapore dollars  
  • Malaysian ringgit
  • Croatian kuna

 

Interest Rate Risk

Interest rate risk is the risk that the fair value on future cash flows of a financial instrument will fluctuate because of changes in market interest rates

The consolidated entity's exposure to market interest rates relates primarily to:  

  • Cash and cash equivalents  
  • Non-trade debts receivable from related parties and other unrelated parties  
  • Bank overdraft  
  • Non-trade amounts owing to directors, related parties and other unrelated parties
  • Syndicated Facility
  • Commercial bills
  • Other short-term borrowings

 

Equity Price Risk

The consolidated entity is exposed to equity price risk arising from equity investments. Equity investments are held for strategic rather than trading purposes. The exposure to the risk of a general decline in equity market values is not hedged as the consolidated entity believes such a strategy is not cost effective. The fair value of the equity investments publicly traded on the ASX was $29.75 million as at 30 June 2018 (2017: $36.81 million). The fair value of the equity investments publicly traded on the NZX was $17.09 million as at 30 June 2018 (2017: $19.65 million).

 

Credit Risk

  • Credit risk refers to the loss that the consolidated entity would incur if a debtor or other counterparty fails to perform under its contractual obligations. Credit risk arises from the financial assets of the consolidated entity, which comprise receivables from franchisees, trade, and non-trade debts receivables, consumer finance loans and finance lease receivables. The consolidated entity’s exposure to credit risk arises from potential default of the counterparty, with a maximum exposure equal to the carrying amount of these financial assets.

The consolidated entity’s policies to limit its exposure to credit risks are as follows:

  • The Franchisor constantly monitors and evaluates the financial position of each franchisee;  
  • Conducting appropriate due diligence on counterparties before entering into an arrangement with them. It is the consolidated entity’s policy that all customers who wish to trade on credit terms are subject to credit verification procedures including an assessment of their independent credit rating, financial position, past experience and industry reputation. Risk limits are set for each individual customer in accordance with parameters set by the Board. These risk limits are regularly monitored; and
  • Non-trade debts receivable are subject to regular monitoring and/or periodic impairment testing to ensure that they are recoverable.
  • Finance lease receivables are secured by assets with a value equal to, or in excess of, the counterparties’ obligation to the consolidated entity.

 

Liquidity Risk

Liquidity risk includes the risk that, as a result of the consolidated entity’s operational liquidity requirements:

  • the consolidated entity will not have sufficient funds to settle a transaction on the due date;  
  • the consolidated entity will be forced to sell financial assets at a value which is less than what they are worth; or  
  • the consolidated entity may be unable to settle or recover a financial asset at all.

To help reduce these risks, the consolidated entity:  

  • has readily accessible standby facilities and other funding arrangements in place; and  
  • maintains instruments that are tradeable in highly liquid markets.

 

Capital Risk

When managing capital, the objective is to create long-term sustainable value for shareholders and avoid adverse short-term decision making, whilst maintaining optimal returns to shareholders and benefits to other stakeholders. The aim is to maintain a capital structure utilising the lowest cost of capital available to the entity.

The consolidated entity is constantly adjusting the capital structure to take advantage of favourable costs of capital or high returns on assets. As the market is constantly changing, the consolidated entity may change the amount of dividends to be paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt.