Price target lowered

Harvey Norman (HVN)

Share Price: $1.86

Broker Calls: Sell - Ord Minnett

P/E: 8.59

Market Cap: $1,976 million

Gerry Harvey opened his first store in 1961 and today there are some 250 Harvey Norman stores worldwide, from Malaysia to Croatia. Over the past year, however, Harvey Norman has closed stores, seen others fall into liquidation, and a multi-million dollar development due to house the Harvey Norman homemaker centres has been left vacant.
 
On top of all this, late last year two wholly owned Harvey Norman subsidiaries in Western Australia and one in Victoria went into liquidation; four Clive Peters and three Rick Hart outlets were shut down in the September quarter. Falling sales, a high Australian dollar and intense competition are just some explanations for the sudden closure.

Harvey Norman shares have sunk by 35% over the last year, and some 50% from two years ago. Harvey Norman’s homemaker centres face fierce competition from the likes of Wesfarmer’s Bunnings, Woolworth’s recently launched Masters, as well as global success story Ikea. Commonwealth Bank equities analysts noted that all parts of the company’s global network are weak – with these pressures unlikely to ease.

Harvey Norman - along with the rest of the retail sector - continues to lurch from one disappointing quarter to the next. Merrill Lynch has slashed its earnings by 10%, and its target price from $2.10 to $1.95. The broker notes that Harvey Norman’s sales figures were propped up by clearance sales from its Clive Peters stores as well as a two-for-one laptop deal. Executive chairman Gerry Harvey noted that all retailers in the technology sector were doing it tough as margins and prices fell. Harvey didn’t think that it was going to be a good Christmas - so shareholders take note.

Citigroup and Merrill Lynch have both downgraded Harvey Norman from a buy to neutral due to a 3.8% fall in first-quarter sales, falling margins, weak offshore sales and earnings outlook. Dividend estimates have been lowered.

Meanwhile John Rawicki from Ord Minnett says that bricks and mortar retail conditions are deteriorating across the board. "Online retailers are rapidly devouring market share through more competitive pricing," says Rawicki. "Declining prices in many big-ticket items, such as flat screen TVs, hasn’t helped, and is only expected to make trading conditions tougher for traditional shop front retailers," he says. Rawicki warns that it's not the best sector to be in at this time and that investors should look for alternatives.

Downgrades

Billabong (BBG)

Share Price: $1.82

Price target: $1.60 (CommBank)

Broker Calls: Sell - CommBank, Think Technically, Deutsche

P/E: 4.96

Market Cap: $463 million

John Rawicki of Ord Minnett says that Ord Minnett is steering well clear of the entire retail sector right now. "Retail spending is much weaker due to the negative wealth effects of a sagging equity market, a soft housing market and the likely contagion of the European debt crisis." Likewise Darren Jackson of Calibre Investments says that retail continues to be a challenging market to navigate. One stock that’s been a regular feature in short-selling activity and broker downgrades is surfwear brand Billabong.

Retail shares across the board have taken a pounding, however Billabong has been one of the hardest hit following a recent profit warning. Billabong forecast that first half earnings could fall up to 26 per cent from a year earlier amid a significant deterioration in trading conditions over the past two months. The warning sent the surfwear manufacturer and retailer's stock plunging 44 per cent in a day to $2.03, less than a quarter of the price it traded at earlier in 2011 and well below the issue price of $3.15 when Billabong floated in August 2000.

The rout continued the following day, with stock hitting a record low of $1.70, down more than three-quarters since the start of the year when Billabong traded north of $8.60.

Fat Prophets analyst Colin Whitehead said investors were losing confidence with the ability of Billabong management to generate satisfactory returns. "That confidence has just been consistently smashed around the head with a baseball bat over the last few years because time after time all they do is downgrade earnings," Mr Whitehead said. "If you combine a bad near-term story with a market that is far from optimistic, you are going to end up with a battering on the share price."

Billabong says that it was focused on reducing working capital and maximising cash flow from operating activities, but "the poor macroeconomic and trading environment is hampering the group's ability to clear excess inventory." However it declined to offer full year guidance given the poor macroeconomic and trading environment, and warned that the future was looking bleak. How the tide can turn - just three months ago the company was optimistic enough to announce a dividend.

Morningstar Equities believes that Billabong sales had been hit by poor weather and a strong Australian dollar, while in other key markets of Europe and the US the economic downturn "is likely to ensure retail conditions remain constrained".

The list of bearish analysts is a long one. Commonwealth Bank analysts downgraded their price target for the stock to $1.60 recently and warned the company had few options left to find the $250 million to $350 million needed to restore its balance sheet to health. "There remain some operational risks that we need to see addressed before we can become more comfortable with the company as an investment," CommBank analysts said.

Mark Lennox of Think Technically says to avoid the stock, saying that given the challenging retail environment, he sees little chance of recovery in the immediate term. Ord Minnett's John Rawicki is equally bearish, noting that the surf and sportswear producer is a victim of weaker global economic conditions, such as softer retail spending. "Debt levels are forecast to remain high due to deferred payments," he says. "We suggest the risks remain significant."

Sells

OneSteel (OST)

Share Price: $0.74

Price target: $0.57 (Deutsche)

Broker Calls: Sell - Deutsche, Patersons, Alpha Broking, WilsonHTM

P/E: 5.02

Market Cap: $993 million

Australia’s manufacturing industry has faced the worst period since the Great Depression. Jobs have been axed and the share prices of Australia’s largest steelmakers have plummeted. OneSteel’s share price says it all, down 71% over the past year.

Although its share price performance has been dismal, there appears to be two distinct camps when it comes to the company's future. Patersons, WilsonHTM, Alpha Broking and Deutsche all have firm sells on the stock and RBS has downgraded it and halved its price target. Meanwhile JP Morgan, Credit Suisse, Macquarie and UBS all have Outperforms or Buys on the steelmaker, with JP Morgan placing a price target of $1.59 on the stock - more than double its current value.

However when looked at more closely, all the bullishness looks decidedly bearish. JP Morgan has slashed its price target twice, Credit Suisse says it "can't see anything positive in the near term", UBS's Buy is based solely on a bullish view on iron ore prices (it thinks the steel side of the business has its problems). Meanwhile Merrill Lynch has cut its price target and placed a "high risk" on the stock.

Cleo Nanni of Alpha Broking isn't keen on the distributor and recycler of metals and steel related products. "In our view, weak guidance from the company reflects the steep decline in iron ore prices," says Nanni. 

James Georges and Hamza Habib from Patersons also have firm sells on the stock. "The balance sheet is weak with about $2 billion of net debt," says Georges. "Earnings are subject to exchange rates and steel and commodity prices - all beyond management’s control - sell on rallies." Habib says that given the substantial change in earnings, current market conditions may not be favourable for the company to recover in the short term. "The company’s iron ore business, representing more than 80 per cent of full-year 2012 EBIT, is currently under pressure."

Peter Day from WilsonHTM is another with a sell on OST, pointing out that this steel maker and iron ore exporter's future is grim following its announcement of a first half profit downgrade after the recent slump in iron ore prices.

>> Click here to go back to the newsletter to read other articles