With the housing market on a tear, Harvey Norman’s (ASX: HVN) profits jumped 49% to $212m this year. That’s a fantastic result, but it’s still only around half what the company earned in 2007.
Revenue has increased 14% since then, but operating expenses have increased 33%. As the profitability of stores declines, it calls into question the value of the underlying property.
For a company like Harvey Norman, shareholders often take comfort that the share price of the cyclical retailer is backed by ‘real assets’. The company owns 81 of the 283 sites it operates, primarily the non-shopping centre based sites in Australia and New Zealand, and the portfolio has a balance sheet value of $2.3bn based on market valuations taken every three years.
However, the properties are mostly tenanted by Harvey Norman franchisees and a sustained drop in profits would lower the value of these stores – significantly so if the franchisee must close up shop, leaving the property to be valued on its ‘next best use’ (often residential development).
A similar situation is playing out in the UK where the country’s largest food retailers are having their margins squeezed by low-price foreign competitors, such as Aldi. Grocers like Tesco face large writedowns on the value of their properties when stores are closed – from 35% to as much as 70% according to Goldman Sachs.
The share price of Tesco has already lost half its value over the past year and Warren Buffett called his investment in the company a ‘huge mistake’. With the likes of Woolworths’ Masters (ASX: WOW) and JB Hi-Fi (ASX: JBH) slowly nibbling away at Harvey Norman’s market dominance, perhaps one day Gerry Harvey will think holding on to HVN was one too.
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