Harvey Norman Holdings Ltd. Analysis

This assignment provides an in-depth analysis of Harvey Norman Holdings Ltd.'s financial performance, market analysis, and capital structure. The company's revenue growth rate is compared to the industry average, with a strong performance in furniture retailing but lower performance in computer and software sales. The analysis also examines the impact of changes in accounting treatment on receivables from franchisees and loans to franchisees. Additionally, the assignment explores the macroeconomic conditions affecting the market and their influence on franchese sales.

INTRODUCE TO ACCOUNTING AND FINANCE
BUS5IAF
Financial Management Analysis
Student name: TIEN DUY DUONG
Student ID: 19131874
Due date: 20/10/2017
Summary
This report will analyze the financial management of Harvey Norman Holdings Limited that
primarily operate in Australian retail market. The report includes four parts: debt valuation, share
valuation, cost of capital, and market analysis with a purpose is to report the performance and
effectiveness of financial management of the company.
I. Debt Valuation
1.
Short-term debt
Interest-bearing loans and borrowings (current) 2014
$000
2015
$000
2016
$000
Secured
Non trade amounts outstanding:
Bank overdraft 29,785 32,620 36,243
Commercial bills payable 9,750 9,750 9,750
Syndicated Facility Agreement 370,000 170,000 260,000
Other short-term borrowings 7,368 101,808 102,110
Lease liabilities - 139 364

Unsecured
Derivatives payable 105 4,104 325
Non trade amounts owing to:
Directors 41,121 78,972 38,134
Other related parties 11,723 10,956 5,932
Other unrelated persons 20 89 177
Total interest-bearing loans and borrowings
(current)
469,872 408,438 453,035
As the above table, the short-term debts used by the company mainly derived from Syndicated
Facility Agreement, bank overdraft and owing to directors. Besides, the company has some
sources of the short-term debts such as commercial bills payable, other secured short-term
borrowings, lease liabilities, derivatives payable, owing parties and persons.
Long-term debt
Interest-Bearing Loans and Borrowings (Non-
Current)
2014
$000
2015
$000
2016
$000
Secured:
Non trade amounts outstanding:
Other borrowings
Syndicated Facility Agreement 142,000 290,000 200,000
Lease liabilities 1,042
Other non-current borrowings 87,383 - -
Unsecured:
Derivatives payable 8,711 - -
Total interest-bearing loans and borrowings (non-
current)
238,094 290,000 201,042
As the above table, the main source of long-term debts used by the company is Syndicated
Facility Agreement. Other non-current borrowings and derivatives payable are also used by the
company.
2. Debt structure

2014
$000
2015
$000
2016
$000
Short-term debt 469,872 408,438 453,035
Long-term debt 238,094 290,000 201,042
2014
%
2015
%
2016
%
ST Debt to Equity 14.27% 8.15% 8.83%
LT Debt to Equity 7.23% 5.79% 3.92%
Total Debt to Equity 21.5% 13.94% 12.75%
LS Debt to Equity of retail industry: 9.21%
LT Debt to Equity of retail industry: 28.83%
(source: http://www.reuters.com/finance/stocks/financial-highlights/HVN.AX )
Following the comparison between the debt ratio of Harvey Norman Holdings Ltd and the
average debt ratio of retail industry, it indicated that the long-term debt to equity ratio of the
company is significant lower than that of the retail industry while the short-term debt to equity
ratio of the company is higher than that of industry in 2014 and approximately equal to industry
ratio in 2015 and 2016. The debt structure of the company may be consistent with the retail
industry.
3.
Retail industry is a sector involving buying final products or services from manufacturer and
selling these products and services to customers. So the company does not rise a heavy level of
long-term debt to construct factory or buy equipment. Moreover, Harvey Norman Holdings focus
on investment in franchise system which requires less startup fees because the franchise system
has been tested by trial and error daily operations previously. Besides, the receivable turnover is
quite low which means the profits can turn back to the company in a short-term period so the
company is efficient in using higher proportion of short-term debts. Furthermore, retailing is

affected by seasonal factor, if the company want to expand their products, they just need to use
short-term debts to cover it.
4. The cost of debt
2014
$000
2015
$000
2016
$000
Financial costs 36,437 32,872 28,706
Total Debt ( excluded non-interest bearing) 707,855 698,306 653,575
The cost of debt 5.15% 4.71% 4.39%
After tax cost of debt 4.99% 4.57% 4.26%
The cost of debt and the after tax cost of debt have been reduced from 4.99% in 2014 to 4.26% in
2016 which proved that the company is earning a positive profits and able to pay their debts.
II. Share valuation
1. Cost of equity
The cost of ordinary shares based on the CAPM,
The cost of equity =Risk-Free Rate of Return + Beta * Market risk premium
Risk- free rate of return is based on Australia Bond 10 Year Yield:
2014 2015 2016
Australia Bond 10
Year Yield
3.546 2.990 2.007
(source: https://au.investing.com/rates-bonds/australia-10-year-bond-yield-historical-
data )
Market risk premium is 6%
Beta is measured by using the regression on the Harvey Norman Holdings’ stock price

Beta= 0.91
(source:http://datanalysis.morningstar.com.au.ez.library.latrobe.edu.au/af/
company/pricesensmeasures?ASXCode=HVN&xtm-licensee=datpremium )
The cost of equity in 2014 = 3.546% +0.91*6% = 9%
The cost of equity in 2015 = 2.99% +0.91*6% = 8.45%
The cost of equity in 2016 = 2.007% +0.91*6% = 7.47%
2.
2014 2015 2016
Total revenue (AUD) 2,547,286,00
0
2,718,437,0
00
3,026,243,0
00
Net profit (AUD)
212,238,000 268,914,000
351,340,00
0
EPS (cents/ share) 19.91 24.48 31.36
Dividends per share ex.special (cents/ share) 14.00 20.00 30.00
Growth expectations % 55.56 44.90 50.00
(Source: datanalysis.morningstar.com.au)
From the above table, the total revenue of the company has been increased from
$AUD2,547,286,000 to $AUD 3,026,243,000, while the net profit has been also increased from
$AUD212,238,000 to $AUD351,340,000 at the same period. It indicates that the company is
efficient in operations and management its cost and expenses.
EPS of the company has a increased tendency from 2014 to 2016, which means that it is a good
sign of higher earnings and strong financial performance, but the dividend per share also
increased with growth rate is relatively high, around 50%. It indicates that the company is raising
the capital based on the equity- that the company is not good at using their capital to create
income.
3.
*Comparable approach

VE = P
E * E1
Comparable Company P/E ratio
2014 2015 2016
HVN 14.96 18.40 14.33
JBH 14.42 14.16 15.78
MYR 13.73 9.52 14.29
Average 14.37 14.03 14.8
2015 2016 2017
Est. EPS( cents per
share)
24.54 31.36 40.35
(Source: datanalysis.morningstar.com.au)
VE 2014 =14.37*0.2454= $AUD 3.53
VE 2015= 14.03*0.3136= $AUD 4.4
VE 2016= 14.8*0.4035=$AUD 5.97
In the comparable approach, the value of the company’ share is affected by the estimated P/E
ratio and the estimated earnings per share in the next year. The share price will increase, if the
estimated P/E ratio and E1 increase, and reverse.
*Constant dividend growth rate model VE= D 1
r−g = D 0∗ ( 1+ g )
r−g
2014 2015 2016
rE 9% 8.45% 7.47%
Estimating an average dividend growth rate using CAGR using the historic data of dividend in
the past 11 years

Year Dividends
2003 0.035714
2004 0.064286
2005 0.05
2006 0.057143
2007 0.085714
2008 0.1
2009 0.085714
2010 0.1
2011 0.085714
2012 0.057143
2013 0.064286
CAGR= (0.064286/0.035714)^(1/10)-1 = 0.06054 = 6.054%
Estimate dividend growth rate g = 6.054%
2014 2015 2016
Dividend 0.085714 0.1286 0.185714
VE 2014 = 0.085714∗(1+0.06054)
0.09−0.06054 = $AUD 3.09
VE 2015= 0.1286∗(1+0.06054)
0.0845−0.06054 = $AUD 5.69
VE 2016 = 0.185714∗(1+0.06054)
0.0749−0.06054 = $AUD 13.7
In the constant dividend growth rate model the value of the company’s share
is affected by three variables D1, rE, and g. But D1 is simply calculate by D0
multiplied (1+g). Therefore, the price of the share depended on the constant
dividend growth rate, g, and the required rate of return, rE. if the constant

dividend growth rate increases, the share price will increase, while, if the
required rate of return increases, the share price will decrease.
4.
2014 2015 2016
Market Price
(AUD)
3.1 4.51 4.61
Price
( comparable
approach)
3.53 4.4 5.97
Price ( constant
dividend growth
rate)
3.09 5.69 13.7
For comparable approach, the share price in 2015 is the most reasonable compared to the market
price. For constant dividend growth rate, the share price in 2014 is the most reasonable compared
to the market price. So, there is difference in two approaches because of each assumptions of two
approaches.
5. Additional data and information for valuing the stock
The value of the company’s stock is affected by some factors such as the firm factors, economic
factors. The level of risk of the company and the share market impacts the required rate of return
resulting P/E ratio. Besides, dividend policy is also important, if the company retain and reinvest
their earnings, it will be able to grow in the future. Furthermore, the company’s investment
opportunities will stimulate the growth of earnings and dividends.
III. Cost of capital
1. The weighted average cost of capital (WACC)
WACC= kD*(1-T)*WD + kE*WE
T= 30%

Capital structure
2014
$000
2015
$000
2016
$000
Short-term debt 469,872 408,438 453,035
Long-term debt 238,094 290,000 201,042
Ordinary shares 3,293,182 5,008,824 5,128,878
Total 4,001,148 5,707,262 5,782,955
2014: WD = 469,872+238,094
4,001,148 = 0.18= 18% WE = 3,293,182
4,001,148 = 0.72 =72%
2015: WD = 408,438+290,000
5,707,262 = 0.122= 12.2% WE = 5,008,824
5,707,262 = 0.878 =87.8%
2016: WD = 453,035+201,042
5,782,955 = 0.113= 11.3% WE = 5,128,878
5,782,955 = 0.887 =88.7%
2014 2015 2016
kD 5.15% 4.71% 4.39%
kE 9% 8.45% 7.47%
WD 18% 12.2% 11.3%
WE 72% 87.8% 88.7%
WACC 7.38% 7.98% 7.12%
2. The company tax-rate
Because the interest expense is subtracted from operating profit before calculating income tax.
So this decreases the tax amount of company which is equal to the amount of interest expense
multiplied by the company’s tax rate. Therefore, after tax cost of debt is equal to the required
rate of return multiplied by 1 minus the tax rate.

3.
Because the cost of debt is paid out by interest and it is subtracted from operating profit before
calculating income tax, while, ordinary share dividends is paid out after tax is paid. So there is
only the cost of debt is affected by tax.
4.
Current liabilities should be not included in the cost of capital calculation because current
liabilities includes other liabilities which are not sources of capital such as account payable,
income tax payable, provisions, etc. Furthermore, the company cannot use these sources to invest
in an opportunity. So, excluding these sources from the cost of capital calculation will help to
calculate the cost of capital accurately, but in some cases as an internal project, these sources can
have effects on the cost of capital.
5.
The WACC is used to calculate the net present value of a business when the company want to
take a merger or an acquisition. Furthermore, the WACC is used to determine the discount rate
for a new investment opportunity. If the rate of return of the investment opportunity is lower than
its WACC, the company should not invest in it, and reverse. Besides, WACC is used to evaluate
the performance of the company in generating the added value for shareholders.
6.
7.
Capital structure
2014
$000
2015
$000
2016
$000
Short-term debt 469,872 408,438 453,035
Long-term debt 238,094 290,000 201,042
Ordinary shares 3,293,182 5,008,824 5,128,878

Total 4,001,148 5,707,262 5,782,955
2014 2015 2016
Total Debt to Equity ratio 21.5% 13.94% 12.75%
Total Debt to Equity of retail industry: 38.04%
( source: http://www.reuters.com/finance/stocks/financial-highlights/HVN.AX )
In overall, total debt to equity ratio of the company has a decrease tendency from 21.5% in 2014
to 12.75% in 2016 and it is lower than the industry’s ratio which means that the company is good
in management and effectively using their debts. Therefore, the capital structure of the company
is not completely consistent with the industry.
8. Optimal capital structure
2014 2015 2016
After tax cost of
debt
4.99% 4.57% 4.26%
Stock price 3.1 4.51 4.61
Market value of
the firm 4,001,148,000 5,707,262,000 5,782,955,000
WACC 7.38% 7.98% 7.12%
(Source: datanalysis.morningstar.com.au)
From the above table, the WACC of 7.12% maximizes the market value of the company
($AUD5,782,955,000) and the stock price ($AUD4.61) at the lowest cost of capital.
According to Riaz, Bhatti, and Uddin (2014), the raising of the level of profitability will result in
decreasing the debt to equity ratio because, companies are more likely to reinvest and use the
equity rather than raising the debt. Furthermore, they also said that when the economy faces to

high inflation, the company will tend to use more the debt to fulfill the shortage of equity which
is a consequence of losing in profitability.
IV. Market analysis
1.Financial performance
According to IBISworld (2017), Harvey Norman has a good financial performance through all
operating segments. In the furniture retailing industry, the revenue’s growth rate of the company
in 2016/2017 is 8.7% over the industry growth rate, reach $1646.5 million. The company
expanded their market share to become the largest player in this industry. Because of promoting
the Harvey Norman, Domayne and Joyce Mayne brands, the company applied the price
discounting and marketing strategy leading to the reduce of profitability. In the domestic
appliance retailing industry, the company’s revenue increased by 3.2% through 2016-2017
(reach $3.2 million) over the growth rate of the industry because of a significant increase in
franchisee sales. In computer and software industry, the performance of the company is lower
than overall industry performance. But the revenue of the company is expected to 880.6 million
(by 1.2%) in 2016-2017 period and has a strong comparision with JB Hi-fi Limited- a major
compertitor.
2.
According to Mitchell (2017,Financial Review), after changing the accounting treatment,
receivables from franchisees or loans to franchisees decreased from $943 million to $535
million. One analyst said “They've taken away that implied guarantee so the balance sheet
almost halved”. It is because the company excised working capital and stock, so they are not
able to ensure the debts.
3.
Due to the macroecomomic conditions are changing in the market which the company is
operating, housing conditions in Australia and some overseas countries are strongly developing.
This resulted in significant increasing of franchsees sales, 5.33 billion, up by 7.6% in 2016 in
comparision with 3.7 % in 2015.