At present hhgregg (NYSE:HGG) is a niche player in the retail Consumer Electronics (CE) and Home Appliance (HA) space, ranking 26th in sales in 2010. Their 2011 sales rank was also 26 showing no improvement. This as compared to a chain like Barnes & Noble (NYSE:BKS) that went from 43rd in 2010 up to 27th in 2011. We see the company as stagnating and grinding downward in share price. Hhgregg is facing several headwinds in the near (next 12 months) to mid term (3 years).
1. Commoditization of low- to mid-range consumer electronics.
Hhgregg competes primarily in the low to midrange price zones on video and home appliances featuring brands such as Samsung, LG, Maytag and Fridgeaire. The value proposition for consumers at this level is almost exclusively price. The free standing CE/HA retailer is turning into a showroom where consumers visit to touch the item and possibly speak to a knowledgeable sales person. They then either travel to a discounter such as Walmart or place their order online with a web only merchant. The CE & HA categories made up 82% of total sales in 2011. The industry is trying to push premium features such as 3D to maintain margin for retailers, but the adoption rates are lagging estimates. Additionally the target consumer at the hhgregg is not generally seeking cutting edge technology. This assumption is supported by the brands and price points that hhgregg sells.
2. Cost and tax structure currently favors web-only sellers.
The online CE/HA retailer has an enormous advantage out of the gate based simply the lack of physical real estate and its associated costs. When we combine the tax advantages with lower overhead, web only merchants have a significant cost advantage. See the chart below for online tax status
The sales of the top 10 CE/HA retailers grew about 6% in 2011. This is a bit of a recovery from the 2009-10 figures, but still not robust enough to support the number of entrants in the field. Tied into this is the decline of about 14.5% from 2009-2010 in spending on CE by the average US household. To have any real chance of success the brick and mortar shops need a very strong online presence as well. As we can see from the graphic below Amazon, to choose a web only retailer, has from a 19% up to a 30% price advantage over traditional bricks and mortar. Hhgregg pricing is on the norm somewhere between Walmart and Target, so we see that unless the purchase is urgent, a consumer is setup to save about $190.00 or so on a $1000.00 purchase.
3. Consumers are stagnating in their purchasing trends.
To break out from the above statistic on percent sales, video in 2011 accounted for 46% of net sales. This is going to be a challenge in the quest for profitability as the television market in the US is maturing and in fact for the next 3-5 years may shrink. There is a definite over supply as manufactures ramped production last year and demand never materialized as the global economy remained stagnant at best. Compounding the issue for retailers is the consumer addiction to sales, coupons, etc. The public has been trained to expect heavy discounting and a continued downward price trend on consumer electronics. Home appliance sales, which made up 36% of hhgregg sales are also experiencing tepid demand.
When your two largest segments are shrinking and your competitors have significant price leverage and a much more varied selection than you do gaining share is going to be a challenge.
4. Growing the number of stores is crimping profits.
Hhgregg is expanding rapidly in terms of store openings. Unfortunately this may come back to hurt them. While opening stores will give some volume etc. the costs of doing so hastily cannot be overstated. It seems that since Circuit City's demise that hhgregg is taking over some old Circuit City locations on their way to the stated goal of 35-40 new stores in 2012. This choice must be questioned as you are going into the location where someone has failed and will try and sell the same product lines and more than likely charge more for them. A case can certainly be made that the sales staff is better trained, the stores are more attractive etc. but the bottom line is that someone before you was selling copy paper and could not sell enough to pay the rent.50 new stores. If a store location needs to be closed, the cost is significant both in financial and operational terms. As stores are opened, even if they are successful it will take an average of ~3 years for them to contribute cash payback.
5. Competitors are larger and more ubiquitous.
No matter where you turn when the product mix is low to mid range, economies of scale are critical. Hhgregg is significantly smaller than the top players in the CE/HA space. To some that would suggest room to grow. To us it seems that the company cannot grow. One of the positives that would be stated is that hhgregg has been in business for over 50 years. For this time the company had been continuing a slow regional growth pattern. Even as hhgregg expands we need to look at Walmart, Target, and even BestBuy as serious road blocks to increasing market share and profitability at hhgregg. To attempt to compete with these larger retailers on price and breadth of offering would require resources far beyond what are available. Thus we see a chain with little chance of significant share price appreciation in the years ahead.
The market in the CE/HA space is extremely competitive and dominated by large (Walmart, Target, Lowes, Home Depot) brick and mortar stores on one side and web juggernauts (Amazon & eBay) on the other. This leaves precious little space for smaller chains unless they are operating in the very high end ranges and or specializing on very complex custom design and integration. Hhgregg does neither. In 2007 the company became public. We propose that the timing of this is poor and will not result in significant new growth. The housing bubble had not yet burst and there was a window of opportunity bring this kind of company to market. Had the economy continued in high growth mode, perhaps a few more years would have passed prior to the tide going out on this type of play. As it stands however, the market for companies of this type is, in our opinion, moving in the wrong direction.
The best possible outcome for share holders would be a buyout, but you need to think around the long way to see it. BestBuy, which is the obvious direct competitor, is locked in a battle for its own survival on the CE front. That leaves the very interesting possibility of a big box home store acquiring hhgregg. This is one that would be in our minds a potential game changer and force the other leader in that segment to look at BestBuy. By bringing the CE piece that the home improvement stores do not do well in, they will benefit. Additionally they have eliminated a competitor in the HA segment. Will such a takeover happen? Possibly and if it does the short trade will (obviously) run over. That is a chance we will take.
We feel the proper position on HGG is to be short and have a breakdown target of $9.20 and we would then look for a downtrend to play out into the $6.80 area.