Harvey Norman to Lose Out as Price Becomes the Key Differentiator for Retailers

Harvey Norman increased like-for-like sales from its core Australian operations by 3.6% for the three months ended 31 March. We expect growth to slow in the fourth quarter of fiscal 2014, reflecting recent declines in consumer confidence. We make no change to our fair value estimate of AUD 1.70. This is well below the market price so we view the shares as materially overvalued. We differ from the market because we expect sales data to remain weak while operating costs increase at a faster rate and dilute future returns. Over the longer term we expect competition for branded products will increase as consumers are drawn to value and the convenience of shopping online. We also expect the larger retailers such as Wesfarmers and Woolworths will move into selling a range of electrical and household goods through their hardware branded stores. We expect price to become an increasingly key differentiator in determining where consumers transact. Those retail companies which can deliver goods to the consumer at the lowest cost, either through a low-cost online business or through cost advantage achieved through scale, will take market share over time.