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3 reasons to be wary of Harvey Norman Holdings Limited

Despite having a larger market capitalisation than JB Hi-Fi Limited (ASX: JBH) and Myer Holdings Ltd (ASX: MYR) combined, Harvey Norman Holdings Limited (ASX: HVN) seems to have slipped off the radar screen of many investors – this might be justified.

While Harvey Norman’s share price has provided a good return to shareholders over the past 12 months, with the stock rising nearly 16% compared with a gain of just 5% from the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO). However, over the past five years the share price is up less than 4% compared with a 44% gain from the index, a 57% rise in JB Hi-Fi’s shares, and a 43% fall in the value of Myer’s shares.

The 10-year chart doesn’t paint a much prettier picture either with Harvey Norman’s share price up just 15% since May 2004, compared with a 62% rise in the index and a sensational 782% leap in JB’s share price.

Despite the solid one-year performance, the weak medium and long-term performance of Harvey Norman’s stock is arguably a more accurate reflection of the long-term outlook for this company. Here are three reasons to be wary.

1) Harvey Norman is trading on a forecast price-to-earnings ratio of 17.3. At this multiple, the stock price is already factoring in a recovery in earnings for what is a low growth company.

 

2) The retailer’s attempt to grow via overseas expansion has been a predictable failure. It’s almost beyond comprehension why a successful Australian-based retailer would decide the best way to spend shareholder funds was to travel halfway around the world to countries they had no experience in and literally ‘set-up shop’.

 

3) Headwinds to dominate. While a housing construction boom should eventually flow through to increased sales for Harvey Norman, the company continues to face pressure from both domestic and foreign online electronics retailers. There’s also new global market entrants in the furniture and home wares space, and a Federal Budget and slowing economy which will restrict overall spending levels.

 

Structural changes have reduced Harvey Norman’s previously solid retail market share. The headwinds facing the company are likely to persist and while the company may claw back margin through a combination of closing underperforming stores (particularly overseas), and increased same-store sales revenues, this appears to already be reflected in the share price.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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