By Patrick Avenell

The publicly listed Harvey Norman Holdings Limited has a “solid investment case” despite the year-on-year decline in net profits announced last week, according to RBS analyst Daniel Broeren. Interestingly, the caveat for this description is not an increase in competition but a decrease.

“We believe Harvey Norman has a solid investment case, however, investors risk downside earnings surprises near term if competitor store closures continue,” Broeren said. “Property assets underpin the valuation in our view, but still hold risk given tight links to the viability of the retail operations, particularly if margins don’t recover in 2H13.”

Harvey Norman chairman Gerry Harvey said last week that the Retravision Southern and WOW Sight & Sound collapses had significantly affected sales and margins due to the receivers of these former networks clearing stock at unprecedentedly low prices.

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Broeren’s cautiously optimistic analysis of Harvey Norman is based in part on the refurbishing of up to 50 Harvey Norman outlets to make them more attractive to consumers. Although retail’s biggest advantage of online in customer service, Broeren said these new stores would actually have less one-to-one service.

“The main investment for Harvey Norman will be in self serve ‘saddle tables’,” he said. “Overall, the new refurbished format is intended to reallocate space to better performing categories, away from AV/IT to higher gross profit home appliances; introduce a lower labour cost model via self-serve merchandising; and to expand the product range to include more fashion-based products with the intention of driving higher repeat purchases.

“In isolation, the refurbishment program has the potential to deliver a revenue uplift, a positive margin mix shift and cost of doing business savings.”

One interesting note from Broeren’s research is an insight into the “franchisee support” that Harvey Norman has been discussing vaguely in its reports to the Australian Securities Exchange (ASX).

“Franchisee support is required only when a franchisee is not generating sufficient operating income to support a base salary of $60,000 plus a car allowance. As such, the number of loss-making stores has clearly increased.”

Harvey Norman listed its FY2012 franchisee support payments at $124.2 million.