The stock market is a curious place. Trillions of dollars flow around the world every day, with investors betting on stocks to go up, down and sideways. A US firm recently held a competition amongst analysts to see who could point to the best example of a stock that may be about to crash and burn. Unfortunately for Australian investors, gadget lovers and one billionaire in particular, the winning entry is a scathing analysis of Harvey Norman and its business model.
The FactSet competition is run by a New York firm called SumZero, and it's designed to find the best theoretical "short sell" stock for global investors. Short selling is basically the market practice of betting on a stock to go down. Essentially, when you short sell a stock, your broker lends you the stock, the shares are sold and if/when the stock price decreases (short-term) you must repurchase the stock for the broker and you receive the profit (difference). If the price of the stock goes up, you must still re-purchase it, even though you may lose money.
The winning entry from the SumZero competition came from an analyst from APS Asset Management. The disclaimers on the report say that in no way is it meant to act as market advice or information, but it makes some interesting observations about Harvey Norman's business model.
The report makes nine keen observations about everything from Harvey Norman's property and asset management activities with franchisees, through to its financial structure and market forces leading to the recommendation to short the stock.
One of the most compelling sections talks about the competitive marketplace Harvey Norman has to deal with in recent times.
While Harvey Norman dominated the big box retail space in the 1990's, it's struggling to compete in a world where consumers are exposed to online stores from here and overseas retailers like Amazon. You may remember Gerry Harvey was the head of a campaign to lower the GST threshold on imported goods so that international businesses couldn't squeeze local gadget suppliers like him out of the market with cheaper wholesale prices. It didn't work, mind you, and Harvey is still bitter.
Harveys is also suffering from the rise of retailer JB Hi-Fi, which pioneers a similar business model which it operates at a much lower cost.
From the report:
"While there is no doubt that in good times i.e. a decade or so ago, the Harvey Norman franchise system worked well and franchisees did well. Today, times have changed with the advent of significant competition, consumer pricing discovery, e-commerce, all creating significant headwinds for Harvey Norman."
Gerry Harvey's recent comments on Australia's high wages were also mentioned as a challenge to the business.
All in all, the 60-page report comes to the conclusion that Harvey Norman as a stock has reached its peak at $3.70 per share:
At 3 year highs of A$3.7 and current valuation, we believe Harvey Norman (ASX: HVN) stock seems overvalued and a compelling short, no durable moat, slow-growth Australian retailer facing multiple headwinds from intense competition. From extensive fundamental analysis of studying competitive position, growth and hundreds of footnotes from public filings over many years, we believe current valuation seems unlikely to be sustained due to slow growth, intense competition exacerbated by limited financial disclosure for investors.
The reason Harvey Norman's share price got so high, according to the report, isn't because it's a good business, but because of positive market forces in Australia like the housing "bubble" and the weak Australian dollar in 2014 compared to the $US.
Now you'd think that a competition entry wouldn't draw the attention of billionaire gadget mogul, Gerry Harvey, but he's hit back against the report today, calling it a publicity grab.
Speaking to the Sydney Morning Herald, saying that the report misunderstands Harvey Norman's business model, adding that he has the right to refute the claims.
If you like a bit of stock trading and market talk, you can read the full report on the Harvey short right here (PDF).
Peter Terlato also contributed to this report.