In response to last week's article discussing the investment merits of hhgregg at current prices, a number of readers have pointed out that the company appears to be suffering from competitive pressures. Return on equity has been declining steadily over the last three years, as shown below:
Undoubtedly, hhgregg operates in a highly competitive space. Not only does it have to battle with proven, conventional retailers such as Best Buy and The Home Depot, but it also has to deal with growing and constantly-improving online threats. However, before getting carried away with this negative assessment, it's important for investors to understand the source of the reduction in the company's return on equity.
Return on equity, which is net income divided by equity, can be broken down into several factors, as follows:
Income / Equity = Income/Sales * Sales/Assets * Assets/Equity
The following table depicts these factors for hhgregg over the last several years:
Clearly, the reason for the drop in ROE is predominately due to a reduction in Assets/Equity (depicted in red in the table above), otherwise known as leverage. The company has paid down its debt, and now holds a decent-sized cash balance. As such, it is now a safer company, but otherwise performing just as well as it was a few years ago, when its P/E was much higher. This demonstrates that despite the competition and the tight consumer environment, management has continued to run the business well, as demonstrated by these performance metrics.
Disclosure: Author has a long position in shares of HGG and BBY