JB Hi-Fi reported 1H25 sales growth of 10% and EBIT growth of 9%. Impressive top line growth was hampered by a decline in gross margins and elevated operating cost growth. While good sales trends should continue, the results provide a reminder that gross margin declines are a risk and operating leverage is low. The company’s large cash position does bode well for further special dividends. While dividends and cash flow are attractive to some investors, the valuation remains steep in our view. 

Australian inflation for the December 2024 quarter shows an easing of inflation across retail categories as well as the underlying rate of inflation across the economy. The drop in inflation in food retail is a headwind to sales growth that is likely to persist in 2025 in our view. In non-food retail we have seen a drop in inflation in hardware, electronics and clothing. A further easing of inflation may not eventuate given the lower Australian dollar. Financial markets are increasingly pricing a 25bp rate cut for February 2025, which will be supportive of retail. The bigger issue for us is the overall rate cutting cycle may be shallow and therefore offer only mild stimulus to retail sales. We see lower interest rates boosting retail sales by 0.5% to 1.5%.

JB Hi-Fi’s share price indicates the market has firm expectations that good earnings growth will continue. We explore some of the arguments trying to justify the lofty valuation. Electronics categories are not defensive. Price deflation is common and replacement cycles vary. Just under half JB Hi-Fi’s outsized earnings growth over the past five years is a function of market share gains that will be harder to sustain.

A thought to challenge conventional wisdom about price inflation in retail. Perhaps inflation is now within a sweet spot where retailers have price rises to address rising costs, but inflation is not high enough to crimp demand. On our analysis, more than half the outsized sales growth in retail over the past three years was a function of price inflation. In other words, less than half of the sales growth was heightened demand (volume). See the chart below. Inflation is portrayed as evil. Yet deflation is an even bigger headache for retailers. As it stands, retail inflation is between 0%-5% depending on category. This is lower than the general level of inflation in Australia. We expect more price rises over the next six months, which may contribute to better retail sales growth than some expect even as interest rates rise and broader living cost pressures hurt households.