JB Hi-Fi’s Results Weren’t Great, Here’s Why Stocks Still Rally

Partly, it was the company’s large special dividend, which more than made up for the decline in its regular dividends. But more than anything, the stock’s stunning rise reflects a classic mismatch between expectations and reality. Or to put it another way, JB Hi-Fi’s results were much less bad than expected.

Expect more violent stock price reactions

Net profit came in at around 4 percent of market consensus, and no one expected the usually capital-conservative company to pay a special dividend.

And then there’s perspective. JB never gives forward-looking forecasts. But he said July sales were solid. A 5.2% like-for-like sales increase at JB’s flagship Australian operation far outpaced the 1.3% sales increase seen in mid-June.

After a 10.4% drop in group profit in mid-June, analysts had been expecting JB Hi-Fi’s 2025 profits to fall by around 5%. However, a combination of a better trading outlook for July and a better-than-feared 2024 result will force a rise above consensus expectations. Monday’s rally came ahead of that.

Expect stocks to react more violently this earnings season as the market absorbs underperformance and passive and momentum-based trading strategies exacerbate any initial moves.

At first glance, JB Hi-Fi’s solid July results are not good news for the RBA, which would have hoped that earnings season would have shown that consumers were pulling their weight to help bring inflation down. We will need a wider sample to assess whether JB Hi-Fi simply outperformed the broader retail sector, or whether consumers are really more optimistic than expected.

But investors should be wary of betting that the stock’s rally is sustainable. JB Hi-Fi shares are up almost 35 per cent this year. That’s an impressive performance against a backdrop of higher interest rates (with no cuts until Christmas), gently rising unemployment and falling household savings buffers.

Moreover, JB Hi-Fi’s price-to-earnings ratio currently stands at around 18.5 times, compared with a five-year average of 12.6 times.

Profitability will likely be limited

The 2024 numbers show how well Smart and his team are doing at outperforming the wider retail sector. But growth prospects appear limited. JB Hi-Fi announced a small acquisition on Monday that will help fuel growth over time: a 75 per cent stake in Victorian bathroom, kitchen and laundry retailer E&S Trading, for $47.5 million – and Smart and his team are brilliant retailers. But profitability is likely to be squeezed in several directions.

For one, sales growth will be harder to find. Smart pointed out that promotions and discounts have returned to pre-pandemic levels, before households got all that fiscal stimulus. JB Hi-Fi is out there matching its competitors, which is smart, long-term thinking for a company that is fanatical about protecting market share.

“The truth is, when times are tough, that’s what you do – you go out and promote,” Smart said. “You work with suppliers and create promotions that will drive sales.”

Another clear challenge for Smart is cost. We know from Fair Work’s decision on the minimum wage that labour costs at JB Hi-Fi will rise by about 3.75 per cent next year. About 50 per cent of stores in JB’s Australian branch (and about 70 per cent at The Good Guys) have rents linked to inflation, which is still 3.8 per cent.

But Smart is not alone in solving the cost problem.

An early trend of the reporting season is that costs are rising faster than revenues, which is squeezing profit margins. We saw that at JB HI-Fi. But we also saw it on Monday at CAR Group, better known as Carsales. Last Friday, furniture retailer Nick Scali reported operating cost growth outpacing revenue growth, while REA Group also revealed a strong 18 per cent rise in operating costs, although it managed to keep revenue growth above that, at 23 per cent.

An important topic for conversation

That cost story will be a key theme of August’s reporting season, according to Matthew Ross, a local strategist at Goldman Sachs. Compensation costs grew at nearly twice the rate of revenue in the six months ended 2024—12% wage growth compared with 7% revenue growth—and 75% of sectors saw labor costs grow faster than sales from 2022.

This matters because Australian investors are expecting ASX-listed companies to post strong earnings and profit margin growth next year: ASX 200 industrial companies are set to see earnings per share growth from 5 per cent in FY2024 to 9.6 per cent in FY2025, with most of that growth coming from margins rising from 6.3 per cent to 6.7 per cent.

Ross says that while many companies have been talking about cost-cutting in the past year — the percentage of analyst calls mentioning it has risen from 25 percent in fiscal 2022 to more than 35 percent — the programs announced so far have been fairly modest.

“Given rising economic uncertainty and a renewed focus on the increasingly tight labor market, we expect to see more companies focus on this issue in the upcoming earnings season.”

Where will the axe swing?

Which companies are ready to take action? JB Hi-Fi and Carsales did not announce major cost-cutting moves on Monday, but Ross has a few candidates. He searched the ASX for companies where labour costs account for more than 10 per cent of sales and where labour costs have risen by more than 5 per cent from 2022. He then added another screen to find companies where consensus expectations are for margins to be below trend.

There were 21 names that could announce cost cuts, including APA Group, Incitec Pivot, Helia Group, Sonic Healthcare, Nufarm, Ansell, Origin Energy, Breville, AUB Group, IPH, Bank of Queensland, Iress, The Star Entertainment Group, Smartgroup, Bapcor, Sandfire, Mineral Resources, Seek, South32 and Bluescope Steel.

Carsales also made Ross’ list and appears to be relying on revenue growth to protect profitability. That’s also a fair decision given CEO Cameron McIntyre’s ability to under- and over-deliver over many years.

With the ASX 200 still hovering near record highs, investors should be alert for other examples of costs rising faster than sales. Consensus expectations included a lot of profit and margin expansion. Results like those JB Hi-Fi delivered on Monday, which were less bad than feared, not better than expected, may not be enough.