JB Hi-Fi: Best Buy or bye-bye?

Management believe today's profit downgrade is temporary. We're not so sure

a woman

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JB Hi-Fi Limited (ASX: JBH) announced on 27 April 2012 that even though its sales forecast remains on track, difficult trading conditions have impacted its margins, and consequently, its full year profit will now be lower than expected.

Even though the share price has dropped, the relatively mild share price reaction (especially when compared to the shellacking handed to Seven West Media (ASX: SWM) yesterday) perhaps indicates that the market expected — or at least wasn't surprised by — the result.

We certainly expected it, with my colleague Scott Phillips' first article on JB Hi-Fi here, and more recently here, concerning the potential impact of Amazon's entry into Australia.

JB's CEO has put on a brave face, saying that even though he expects discounting to continue, he does not believe this is a long-term structural change.  He also believes the company may benefit from consolidation in the current environment, and that it will react aggressively to maintain market leadership.

We disagree on both counts.

Misplaced Optimism

Firstly, JB Hi-Fi is facing headwinds in the continued drift of retail online. It is widely accepted that adoption of online technology in Australia is somewhat behind the USA.  As a comparison, by some estimates online retail in the US makes up 20% of total sales, but is only approaching 10% in Australia. This indicates more pain on the way for our retailers.

Secondly, the major 'structural'" change in our retail market involves the collapse of differential pricing.  Differential pricing by manufacturers and suppliers is the main reason why Australians pay more for nearly everything such as cars, books, CDs, clothing, etc. For example, a pair of Levis 501s sells for US$40, and yet retails in Australia for AUD$100.  While there may be some difference in retail margins, wholesale prices to Australia are consistently higher, resulting in higher prices to Australian consumers.

The potential impending entry of Amazon (in addition to existing players such as Kogan) is likely to result in a change in differential pricing practices insofar as consumer electronics are concerned.  This blatant price gouging is unlikely to be condoned by Jeff Bezos, and he can back this up with the massive purchasing power available to Amazon.  Before you know it, JB Hi-Fi will no longer be perceived as having the lowest prices, and this will be the death-knell to its business model.

Of course, other retailers stand to lose in that environment. Clearly in the path of the advancing forces of online retail are Harvey Norman (ASX: HVN), Woolworths' (ASX: WOW) Big W, Wesfarmers' (ASX: WES) K-mart and the department store duo David Jones (ASX: DJS) and Myer (ASX: MYR).

JB Hi-Fi will continue to face relentless assaults on its business model, in a similar vein to those confronting US electronics retailer Best Buy. We believe there are strong parallels between Best Buy and JB Hi-Fi, and the latter's fate may be foretold accordingly.

With the expansion of online retail in Australia (and with the seismic shift of Amazon perhaps not far away), investors must surely question whether JB Hi-Fi will become, as many in the US jokingly refer to Best Buy, merely a showroom for products to be purchased on Amazon.

Foolish takeaway

The world of retail is moving predominantly towards services, or a blend of service/product, consumed on the spot. Perhaps consumers in the future will have to pay money for physical window shopping and physical browsing, with delivery of products being merely ancillary.  This may be wildly speculative, but it is difficult to imagine a scenario where JB Hi-Fi in its current form can remain relevant.

The ASX is already on the move in 2012, and Goldman Sachs experts recently said they reckon S&P/ASX 200 could top 5,000 next year. Read This Before The Coming Market Rally is a must-read for investors who don't want to miss out on the party. Click here now to request your free copy, before it's too late

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