JB Hi Fi Limited

Investment RatingJBH operates over 157 branded electrical stores across Australia and NewZealand and is rapidly growing via an aggressive store roll-out program. Thebusiness has proven to be very resilient, trading strongly throughout thefinancial crisis as the younger target demographic continued to spend onentertainment. The industry constantly develops new gadgets and products,which drives organic growth. New stores will continue to drive earnings growthover the next few years, with many national locations still under represented.What growth opportunities lie beyond the 210 long-term store target remainunclear.

Event JBH expect 1H EBIT to be around 5% below pcp, subject to the Christmas

trading performance being in line with recent months trends.

Impact The 7.8% increase in sales is driven by the opening of 10 stores with a

further six expected to open in the 2H. On a comparable basis sales decline1.8% for the five month period to November which is an improvement from3.5% decline for the first three months to September.

Aggressive price discounting within the electrical market is reflected in theexpected decline in 1H EBIT of 5% compared to pcp. We would havethought the 7.8% increase in top-line sales would have supported the profitmargin as the business generates further operational benefits of scale. TheEBIT decline is a concern leading us to downgrade our profit forecasts.

It remains questionable if the current price discounting and margin erosion isa temporary liquidation event by competitors to clear stock or a reflection ofthe structural market changes posed by online competitors forcing retailersto accept a lower margin.

We take a view that electrical retailing margins will remain under pressure ascommoditisation and the ability to easily access products through onlinecompetitors is set to drive down traditional profit margins.

JBH is actively evolving with its online offering reporting an 80% increase ininternet sale, notably from a small base. Online retailers are at a distinctadvantage because they avoid paying shop rents and the associated fittingsand staffing costs. This competitive threat is likely to ensure tighter electricalprofit margins become more of a norm rather than an exception.

Recommendation ImpactWe revise down our longer term margin assumptions to account for what weexpect to become a lower returning industry as the internet effectively lowersthe barriers to entry within the commoditised electrical retailing segment.

JB Hi-Fi Limited ( JBH )Profit margins on the declineRecommendation: Hold 16 December 2011

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Recommendation Trigger Guide

Note: Marker indicates price of $12.71 at publication date.SnapshotLast PriceMarket Cap.52 Week High52 Week LowShares on IssueSectorMoat RatingIntrinsic Valuation

$12.71$1,256 million$20.50$12.5798.8 millionGICS - RetailingNone$12.76

RiskBusiness RiskPricing RiskCompany BetaSector Beta

HighHigh1.251.34

Investment Fundamentals

Year-end Jun FY10A FY11A FY12E FY13ENPAT ($m) 118.7 134.4 119.8 126.3EPS () 108.4 123.9 121.6 128.2EPS Growth (%) 21.0 14.3 -1.8 5.4PE Ratio (x) 18.0 15.4 12.3 11.7DPS () 66.0 77.0 75.0 79.0Dividend Yield (%) 3.4 4.0 5.0 5.3Franking (%) 100 100 100 100

Source: Morningstar analyst estimates.

Price Chart

Business DescriptionJB Hi-Fi Limited (JBH) is a specialty discount retailer ofbranded home entertainment products. The Group'sproducts fall into consumer electronics, car soundsystems, and music and DVDs and white goods. JBHdoes not operate a warehouse; instead all stock isdelivered directly to each store and largely stored onthe shop floor.

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Attractive low cost business model

Thesis (Last Updated: 08/08/2011)JBH is now Australias sixth largest retailer,having built a strong brand and healthymarket share within the consumerelectronics industry after the demise ofsmaller fragmented groups like Retravisionand Beta Electrical. Australians have beenquick to embrace the latest technology overthe past decade thanks largely to lowunemployment and low interest rates.Competitive advantage comes from JBHslow cost business model similar to listedUS peers Best Buy and Circuit City. Pricedeflation and intense competition arelonger term risks.Stores typically break even just under ayear with mature stores on averagecontributing $20m in sales and $1.4m inprofit. Around half of the existing storenetwork has yet to mature. The businessdoesnt run warehouses and holds all stockat the store level, minimising storage andtransport costs. The business modelrequires high turnover and foot traffic tocompensate for low operating margins onconsumer electronics, music and games.The product mix is updated with recentexpansion into mobile phones andcomputers. Despite this, we still dont thinkthe business carries any economic moat.Consumer electronic products havebecome commoditised while technologykeeps converging.JBH needs to offer good incentives toattract mobile phone customers given thehighly fragmented market. Consumerelectronic margins will also be impacted byprice deflation due to the higher A$ andintense competition. Management openlyboasts its employees are incentivised andoften have the ability to sell at cost to closea deal, sacrificing gross margin.Woolworths (WOW) plans to boost its DickSmith consumer electronics division whilethe entry of Costco into the domesticmarket could further lower already lowgross margins. Film and music distributorscontinue pushing content onlinediminishing the need for physicaldistribution.

Valuation (Last Updated: 16/12/2011)After a period of rapid earnings andrevenue growth driven by a store role outprogram we now expect earnings growth tomoderate to an average of around 6%pafor the next five years. Structural risksassociated with the emerging threats ofonline competitors means we use arelatively high discount rate of 12% andlittle to no margin growth from currentlevels, to determine our valuation of$12.76.

Risk (Last Updated: 08/08/2011)The consumer electronics industry usuallycycles over a ten years period where highprofits encourage new competitors drivingdown profitability. International giantsCostco as well as Woolworths haveboasted plans to compete aggressively inconsumer electronics, possibly flooding themarket with cheap imports as the A$continues rising and Asian suppliers lookfor higher volumes. Online competitors arealso ramping up while film, music and othercontent distributors continue seekingvertical integration by pushing contentonline diminishing the need for physicaldistribution. This will force a rapid changein JBHs product mix over the next five toten years.

Strategy (Last Updated: 08/08/2011)Growth is driven by a store rollout programwhich adds around 13-15 sites per yearwith a long term goal of 214 nationalstores. The product mix is constantlyrevised to ensure competitiveness. JBHsreluctance to take on the new devicesillustrates strict product selection. Margingains derive from scale benefits whichreduce the cost of doing business.Diversification into New Zealand is still inits early stage and is not likely to contributein a meaningful way in the near term.

Bull Points JBHs younger, budget conscious

demographic is less likely to have a

JB Hi-Fi Limited (JBH)

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mortgage and more likely to rent or livewith their parents.

The business has an establishednational network, strong brand andcustomer loyalty.

It has cemented itself as the categorykiller, similar to Bunnings in Hardware.

Bear Points Comparable sales growth will grind to a

halt as consumers wallets tighten.

JBH has no moat and sellscommoditised products.

Physical content will be phased outwithin the next ten years, so will need tofind other products to fill floorspace.

Financial OverviewGrowthGuidance is for FY12 sales revenue ofaround $3.2bn. Another 16 stores will openin FY12.

ProfitabilityFY11 revenue increased 8.3% to $2.96bn,gross margins up 28bps to 22%, the cost ofdoing business remains low at 14.5% withEBIT up 11.9% to $196m.

Financial HealthThe share buy back will increase debt andreduce interest coverage from 33x to 15xutilising our forecasts for FY12.This levelstill remains relatively low with sufficientfinancial capacity to continue the store roleout program.




Per ShareYear to 30 June 2009A 2010A 2011A 2012E 2013EEarnings 89.6 108.4 123.9 121.6 128.2Dividends 44.0 66.0 77.0 75.0 79.0Franking % 100.0 100.0 100.0 100.0 100.0

Profit & Loss ($M)Year to 30 June 2009A 2010A 2011A 2012E 2013ESales Revenue 2,327.3 2,731.3 2,959.3 3,142.0 3,360.8EBITDA 160.7 198.4 223.3 211.9 222.9Depreciation & Amort. -18.7 -23.3 -27.3 28.3 30.2EBIT 142.0 175.1 196.0 183.6 192.6Net Interest Expense -6.5 -5.5 -4.0 12.4 12.2Profit Before Tax 135.5 169.6 191.9 171.2 180.4Tax -41.1 -50.9 -57.5 -51.4 -54.1Adjusted NPAT 94.4 118.7 134.4 119.8 126.3Reported NPAT 94.4 118.7 109.7 119.8 126.3

Cash Flow ($M)Year to 30 June 2009A 2010A 2011A 2012E 2013EReceipts from Customers 2,511.9 2,965.8 3,267.5 3,114.2 3,354.8Net Operating Cashflow 145.6 152.1 109.9 170.6 153.1Capex -44.4 -56.8 -45.1 -36.9 -55.5Acquisitions & Investments -- -- -- -- --Sale of Invest. & Subsid. -- -- -- -- --Net Investing Cashflow -43.9 -55.8 -43.9 -36.9 -55.5Proceeds from Issues 4.2 6.8 9.3 -- --Dividends Paid -33.2 -67.1 -88.4 -73.9 -77.8Net Financing Cashflow -64.3 -80.2 -90.9 -73.9 -77.8Net Increase Cash 37.4 16.1 -24.8 59.8 19.8Cash at Beginning -1.5 35.8 51.7 27.2 87.1Exchange Rate Adjust. -.1 -.1 .3 -- --Cash at End 35.8 51.7 27.2 87.1 106.9

GrowthYear to 30 June 2009A 2010A 2011A 2012E 2013ESales Revenue % 27.3 17.4 8.3 6.2 7.0EBIT % 38.8 23.3 11.9 -6.3 4.9EPS % 45.1 21.0 14.3 -1.8 5.4DPS % 69.2 50.0 16.7 -2.6 5.3

RatiosYear to 30 June 2009A 2010A 2011A 2012E 2013EPrice/Earnings % 12.9 18.1 15.4 12.3 11.7EV/EBITDA % 10.6 10.5 8.5 7.5 7.1Dividend Yield % 2.9 3.5 4.5 5.0 5.3EBITDA Margin % 6.9 7.3 7.5 6.7 6.6EBIT Margin % 6.1 6.4 6.6 5.8 5.7Net Profit Margin % 4.1 4.3 4.5 3.8 3.8ROE % 41.2 40.5 88.2 68.4 56.8ROA % 15.1 17.3 18.1 14.9 14.3ROIC % 35.0 39.4 38.4 33.4 33.3Net Debt/Equity % 23.4 6.1 134.8 73.4 50.9Interest Cover x 21.9 31.8 48.6 14.8 15.8

Balance Sheet ($M)Year to 30 June 2009A 2010A 2011A 2012E 2013ECash & Equivalent 35.8 51.7 27.2 87.1 106.9Receivables 60.3 63.5 58.3 86.1 92.1Inventories 324.5 334.8 406.9 387.8 415.2Other Current Assets 5.7 4.5 8.6 8.6 8.6Current Assets 426.2 454.5 501.1 -- --Prop. Plant & Equipment 136.1 164.0 169.6 178.2 203.4Intangibles 81.4 83.9 78.7 78.7 78.7Other Non-Current Assets 18.0 12.0 17.8 17.8 17.8Total Non-Current Assets 235.4 259.8 266.1 -- --Total Assets 661.7 714.3 767.1 844.3 922.7Interest Bearing Debt 89.4 69.6 232.6 232.6 232.6Other Liabilities 343.0 351.4 382.2 413.4 443.5Total Liabilities 432.4 421.0 614.8 646.0 676.0Net Assets 229.3 293.3 152.3 198.3 246.7Total Shareholders Equity 229.3 293.3 152.3 198.3 246.7

Top 5 Substantial ShareholdersNational Australia Bank Limited 12.0%Integrity Investment Management 8.2%UBS AG and its related bodies corporate 6.8%Hyperion Asset Management Limited 6.5%Westpac Banking Corp/BT Investment Management Ltd 6.3%

Previous Research19/10/2011 Retail weakness continues in September quarter14/10/2011 Price trigger adjustment09/08/2011 Performing in a tough retail environment30/06/2011 Tough trading conditions22/06/2011 Under Review30/03/2011 Buy-back to return franking credits07/02/2011 More to the headline08/12/2010 Blurry picture14/10/2010 Stuck on pause09/08/2010 Good but not great12/05/2010 Should score goals08/02/2010 Becoming attractive16/12/2009 Christmas shoppers aficionado22/10/2009 Store expansion upgraded11/08/2009 Tune in for FY1009/06/2009 Earnings growth continues, store guidance updated27/05/2009 The $100m question

Principals & DirectorsPrincipalsChairman Mr Patrick F ElliottCompany Secretary Mr Richard MurrayDirectorsMr Patrick F Elliott(Chairman)Mr Gary Levin(Non-Executive Director)Mr Richard Anders Uechtritz(Non-Executive Director)Mr Terry Smart(Executive Director)Mr James (Jim) King(Non-Executive Director)Mr Gregory Richards(Non-Executive Director)Ms Beth Laughton(Non-Executive Director)

2011 Morningstar, Inc. All rights reserved. The data and content contained herein are not guaranteed to be accurate, complete or timely. Neither Morningstar, nor its affiliates nor their content providerswill have any liability for use or distribution of any of this information. To the extent that any of the content above constitutes advice, it is general advice that has been prepared by Morningstar AustralasiaPty Ltd ABN: 95 090 665 544, AFSL: 240892 (a subsidiary of Morningstar, Inc.), without reference to your objectives, financial situation or needs. Before acting on any advice, you should consider theappropriateness of the advice and we recommend you obtain financial, legal and taxation advice before making any financial investment decision. If applicable investors should obtain the relevant productdisclosure statement and consider it before making any decision to invest. Some material is copyright and published under licence from ASX Operations Pty Limited ACN 004 523 782 ("ASXO").DISCLOSURE: Employees may have an interest in the securities discussed in this report. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf.




Research MethodologyWe seek undervalued stocks with amedium to long-term investment timehorizon. Companies that make the bestinvestments tend to be those able to growearnings per share year after year andwhich are able grow at rates above theaverage of the market. Earnings growthsupports a solid and growing dividendstream which is the essence of shareholderreturn.

In searching for the best businesses in themarket, we want to see an ability to turnrevenue into profits and a record of strongreturns to equity. The ability to generatestrong free cash flow is critical as this iswhere the funds come from to paydividends or to invest in new growth areas.The greatest free cash flow generators willhave strong margins, good controls overworking capital and limited requirement forcapital expenditure. The best businesseswill also have robust balance sheetsincluding a not onerous level of debt. Webelieve in strong, experienced anddisciplined management.

Recommendations

Our qualitative recommendations aresimple and easy to understand:

Buy: Suitable for purchase now Accumulate: Undervalued but there is

time to purchase Hold: Appropriately priced, neither buy

nor sell Reduce: Sell part holding Sell: Sell all holdings now Avoid: Not investment grade

Economic Moats

The pursuit of high quality businesses iscentral to our investment philosophy.These offer the greatest gains to the longterm investor, so long as they are bought ata reasonable price. The concept ofeconomic moats is valuable in assessingthe quality of a business, with the phrasepopularised by Warren Buffett and CharlieMunger. Just as wide moats protectedcastles from invaders in medieval times,businesses with wide economic moatshave strong defences against their profitsbeing competed away.

We ascribe a moat rating to each stockresearched: Wide, Narrow or None.

The moat is the competitive advantage thatone company has over other companies inthe same industry. Wide moat firms haveunique skills or assets, allowing them tostay ahead of the competition and earnabove-average profits for many years.Returns on their invested capital willexceed the cost of that capital. Without amoat, highly profitable firms can have theirprofits competed away. Other companieswill see how attractive the market is and tryto move in to reap some of the rewardsthemselves.

Sources of economic moats includeinnovation skills or first mover advantages,a superior cost position, the ability toprovide a range of products to suit theneeds of a variety of markets, highswitching costs or locking out ofcompetitors.

The moat rating is just one of theingredients used in determining whether acompany is undervalued, though it isobviously an important one. We are notsaying that no-moat companies should beavoided. Simply, the very best long terminvestments are in wide moat firms boughtwhen they are undervalued.

Intrinsic Value

Intrinsic Value (otherwise known as Fair orUnderlying Value) is the analyst'sinterpretation of what the stock is worthtoday. The stock is considered to beundervalued when the quoted price isbelow this point or overvalued where theprice is above it.

Whether to invest in a stock will depend onconsideration of the prospective return andthe risk undertaken. Prospective returnincludes both share price moves anddividend yield. Our analysts incorporate thestock's risk in their intrinsic value. Otherthings being equal, lower risk stocks willhave greater intrinsic value than higher riskones. A stock becomes a buy when thequoted share price is at a discount tointrinsic value that provides a sufficientprospective return.


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Business Risk

Business risk encompasses alloperational risk and financialrisk. Companies with lowbusiness risk have the mostreliable earnings streams. Achange in business conditionsmay reduce earningspredictability and thereforeincrease risk. Examples aremarket entry of a newcompetitor, unfavourable shifts inthe economy, changes in keymanagement personnel, majorinvestment in an uncertain newventure or acquisition, andincreased interest burdencaused by higher debt levels orraised interest rates.

Pricing RiskPricing risk reflects the premiumor discount implied in the currentprice of the shares. Many growthstocks trade on high earningsmultiples giving them high pricingrisk though they may have lowbusiness risk.

Investors should consider theirrisk tolerance before investing inthe share market. Manyinvestors will decide to have onlylow risk stocks in their portfoliothough others will accept higherrisk levels in order to pursuehigher returns.

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