Do Harvey Norman accounts deliver full disclosure or half-baked disclosure? This is the questions than many analysts are trying to come to grips with.
For anyone who has attended a Harvey Norman AGM you will realise very quickly that Gerry Harvey likes to be in control and if you ask questions that he does not like he will insult you.
At today’s Annual General Meeting Chairman Gerry Harvey at one stage told attendees who he described as short sellers to “piss off”.
When Australian Shareholders Association representative Allan Goldin dared to ask Gerry why he doesn’t re-privatise Harvey Norman if he is not prepared to run it as a public company, Gerry Harvey responded claiming “If you’re telling me I’m not looking after shareholders you’ve got a loose cog in your head,” Harvey told Goldin.
To which he later added: “I’ve answered your stupid questions.”
And as investors were voting on the remuneration report, Gerry added one final insult to Goldin: “Did you vote for Donald Trump?” he asked.
Goldin who is Canadian said “I didn’t vote for Trudeau either”.
Unlike Coles, Woolworths or even arch rival JB Hi Fi Gerry Harvey does not believe in full disclosure of the Harvey Norman accounts.
He fails to break out consumer electronics sales Vs bedding or furniture.
He also fails to break out individual entity sales such as sales achieved by Domayne, Joyce Mayne or Harvey Norman stores.
If he did, this would be called accountability, something that I suspect Harvey Norman has a problem with because it would mean that analysts could compare how the Company is doing Vs similar competitors.
In the consumer electronics market JB HI Fi fully discloses their sales, so does Big W and Coles with their Officeworks operation.
Right now Harvey Norman, is facing a new round of pressure and there is every possibility that things could go pear shaped at the mass retailer.
In the bedding and furniture markets which delivers the bulk of his sales profits, South African retailer Steinhoff International is buying up Australia furniture and bedding retailers. They have clearly targeted Harvey Norman and they have buckets of cash.
Capitalised at US$31 they own their own furniture and bedding manufacturing plants and they can land products in Australia significantly cheaper than Harvey Norman.
Then there is arch rival JB Hi Fi, they have recently acquired The Good Guys and are now the biggest seller of appliances a category where Gerry Harvey has been making money in the past.
Another problem for Gerry Harvey is the fact that Amazon is set to launch in Australia. This is a Company that could eat Gerry Harvey for breakfast. As for the $62M that Gerry Harvey put into a start up to compete with Amazon, this is petty cash for the US online giant.
Then there is the issue of whether Gerry Harvey has in place the right management to run the Company going forward.
While JB Hi Fi has a policy of promoting from within Gerry Harvey has a policy of hanging onto the same tired old management, with several experienced and up and coming managers deserting the mass retailer because they see no management or promotion future ahead of them.
Despite improved company performance, shareholders are becoming more frustrated with Gerry Harvey’s uncompromising leadership style.
Many believe that he does not have the management or the leadership skills to deliver long term growth as the market becomes more reliant on digital sales.
As for the financial accounts issues, which led one proxy adviser to recommend Harvey Norman investors vote against the company accounts at the meeting, Harvey and the retailer’s auditors stood by their explanation.
“There are no franchise bad debts,” said Harvey. “Harvey Norman pays every cent of tax it is obliged to pay”.
Gerry Harvey gave an emphatic rebuttal of allegations the retailer is not paying its fair share of taxes and is hiding problem loans as so-called “tactical support”.
With regard to the allegations, Harvey said: “If you think that we are upset about it you’re absolutely right.”
It was all kicked off by the retailer’s latest annual report, which contained the surprise that it has loans totalling $943 million to its franchisees and had written off $566 million of those loans – what it calls “tactical support” – since 2011.
The AFR Claims that a mystery Mr Deen helps orchestrate a corporate makeover that allows franchisees to walk away from any liability, while old inventory is sold and debt reduced, all before any of this hits the Harvey Norman balance sheet.
Harvey Norman ends up with a loss but it’s not clear when it must be reported – the process is hidden from shareholders – and meanwhile the franchisee has a fresh slate, ready for a new franchise.
The big question that Gerry Harvey fails to answer is why are these franchisees falling over, why is debt being incurred and why does Harvey Norman have to keep loaning money to franchisees if the business is doing so well.
The reality is that Harvey Norman has been forced to dish out more than half a billion dollars of loans to its franchisee network. This is a network that believes it calls the shots when Gerry Harvey is the one calling the shots.
Unlike JB Hi Fi which has a central buying operation, JB Hi Fi has steering committees that are made up of Harvey Norman staff and franchisees. These committees choose which products Harvey Norman will range. It’s then up to the suppliers to call on the individual franchisees to see whether the franchisee will range a product and how many they will stock.
The model is old and fast becoming unworkable for several distributors with some distributors simply quitting the consumer supply market.
Three years ago, Harvey Norman hired Carl Rose the former CEO of Sony to try and set up a central buying operation for TV and audio visual products.
The exercise turned into a shamble because the franchisees wanted to be in control and they despised the idea of Harvey Norman running “Their business”.
And this alone raises another issue as to who controls and runs the franchisees, Harvey Norman management or the franchisees.
The ASA has been a vocal voice at Harvey Norman AGM’s. When they met recently with Harvey Norman management a report on the meeting fell into the hands of Fairfax Media.
“As to reports that Harvey Norman has loaned millions of dollars to franchisees to cover costs of rent, interest and franchise fees as well for funding inventory and then written off $566 million of it over five years, it was explained that these were not loans, but the amounts in question related to tactical support payments,” said the ASA report about the meeting.
“We understand tactical support payments are temporary in nature and are expensed by Harvey Norman in the year that they are made. The franchisee takes this payment into revenue and uses in as they best see fit to running their business.”
According to analysts, Harvey Norman has hit the peak of their earnings cycle, which means franchisees might soon be back under the sort of pressure not experienced since the 2011 and 2012 financial years.
The amazing tailwinds that have underpinned the retailer’s earnings in recent years will soon wane, according to Citi.
“Harvey Norman is approaching the final stages of a multi-year upswing in the earnings cycle, in our view,” said the Citi retail analyst team.
“Unique conditions converged across housing, interest rates, currency and competition which drove exceptional sales and profit growth in both FY15 and FY16. As seen in FY11 and FY12, this operating leverage works in both directions.”
As the team pointed out in the report, which has a “sell” recommendation on Harvey Norman, “operating leverage and subsequent reduction in tactical support has been a far more significant driver of margins over the last three years” than efficiency programs.
Harvey Norman increased tactical support to franchisees in the form of rent, marketing and franchise fee relief from $60 million in 2011 to a peak of $128 million in 2013.
Despite constant questions none of the franchisee loans has ever been described as overdue, impaired or doubtful.
“Given that tactical support is the ‘financial accommodation’ that Harvey Norman decides it cannot pursue for repayment, it is effectively loan forgiveness to a franchisee,” Ownership Matters reported recently.
Fund Managers have questioned the sustainability of Harvey Norman’s franchise structure, pointing out that franchisees paid little upfront capital and received a salary and a car – making them more akin to employees than franchisees.
When I first launched ChannelNews we wrote a story about Harvey Norman management bullying suppliers. Harvey Norman were accused of making rebate demands that big brands said was “way beyond” what retailers in the US and the UK or even Asia demanded.
14 years on Harvey Norman is still making big demands on their suppliers the big question is whether they will be able to do this in 2018 when Amazon are stripping sales and Steinhoff and JB Hi Fi are kicking the mass retailer where it hurts.