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The worst is yet to come for JB Hi-Fi

JB Hi-Fi (ASX: JBH) keeps proving the haters wrong. And good on it. The shares are up a cool 99% over the past year. JB still has 99 problems, though, even if its share price ain’t one.

Yes, full financial year sales rose 5.8%. Same-store sales were also solid with a 3.2% boost in the second half, a marked turnaround from minus 3.5% in the first half. Even gross margins expanded.

Those tailwinds aren’t likely to keep up, though. The bounce off last year’s intense discounting brought on by the liquidations of rivals GAME and WOW Sight and Sound is a one-time boost. It’s hard to imagine a much higher mark on gross margins when they’re already within a quarter of a percentage point of their pre-GFC level of 2007. A weaker Australian dollar won’t help with costs either and a revitalized Dick Smith, which just struck a new deal to run David Jones’ (ASX: DJS) electronics departments, won’t make life any easier.

The steady drumbeat of declining software sales also portends more drama to come. Software, ranging from CDs to games, has shrunk to 21.5% of sales in Australia and fell 8.9% on a comparable basis in the second half. There’s no turning back here as digital content continues to gobble up share.

Speaking of online, JB highlighted its 30% growth in own online sales. Nice. What’s not so nice is that online represented only 1.6% of total sales. Online sales would have to triple from here just to sop up a 5% drop-off in sales at brick-and-mortar stores.

Zooming out, JB will struggle make online work. Competition is fierce and JB won’t be able to keep the same share of online sales that it does offline. It’s also a long shot that JB can compete in digital media (think music, books, and video). Not only does JB lack the selections, ecosystems, and marketing budgets of juggernauts named Apple (Nasdaq: AAPL), Amazon.com (Nasdaq: AMZN), and Google (Nasdaq: GOOG), it also lacks its own hardware to fan the flames of sales. It’s a razor and blades model without the razor.

On top of all the competitive cake is the bitter valuation icing — the shares are fully valued at over 16 times earnings. That’s a rich price for a low-margin business with secular headwinds in a cooling economy.

The End Game

I applaud JB Hi-Fi’s efforts and, as a consumer, I’ve had good experiences shopping there. And, again, my hat is off to the value hounds that had the nerve to buy and hold onto the shares when they were deeply out of favour a year ago.

Competition will only become fiercer in the years to come, though, and at 16 times earnings the shares are priced for growth that isn’t likely to show up.

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Joe Magyer owns shares of Amazon.com and Google. The Motley Fool owns shares of Amazon, Apple, and Google. 

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