The Harvey Norman Holdings Limited (ASX: HVN) share price is recovering from its earlier sell-off but the bounce could be a good time to sell the stock after JP Morgan downgraded the stock.
The HVN share price gained 0.9% to $4.42 in after lunch trade even as the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index tumbled 0.5% with consumer stocks coming under pressure.
That makes the rise in Harvey Norman all the more pleasing for shareholders as the Wesfarmers Ltd (ASX: WES) share price shed 1.2% to $38.64 and JB Hi-Fi Limited (ASX: JBH) share price lost 1.1% to $32.54 at the time of writing.
Rising costs to bite
But the good times won't last. JP Morgan downgraded the stock to "underweight" from "neutral" as it warned that costs are anticipated to increase for the furniture and electronics retailer.
This is because Harvey Norman has entered into "an investment phase" and will need to spend on people, logistics and technology in its franchising division – which was a source of weakness in the group's latest full year results.
Harvey Norman's underlying FY19 profit before tax of $513 million was 3% below the same time last year and lower than the $529 million that JP Morgan was expecting.
While management indicated that like-for-like sales since the start of the FY20 financial year have markedly improved, margins are still at risk as Harvey Norman will have to increase its investment to ensure a sustainable turnaround for its franchisees.
Other headwinds buffeting HVN
But the rising cost base isn't the only thing that could drag on group performance. The broker noted that Harvey Norman's international business, which has been a key earnings growth driver, is showing signs of a slowdown in the second half of FY19 in some markets.
Other headwinds that Harvey Norman has to contend with include the global economic slowdown from the US-China trade war, the growing risk of a hard Brexit, and tough comparables for the group's New Zealand operations (a market where Harvey Norman is aggressively expanding).
"Given these challenges which drove negative earnings revisions, valuation support has reduced," said the broker.
"At a capital level, HVN has made conflicting announcements. The final dividend was far above JPMf, yet HVN announced another entitlement offer, which we think suggests a desire to retain low levels of gearing (19.6% FY19 ND/Equity) despite significant upside with its Capital Management Policy."
The broker has a price target of $4 a share on Harvey Norman.
