Why Woolworths should give Masters more time

Back in 2011 when Woolworths opened its first Masters store, home improvement looked like a great opportunity. Bunnings dominated the $42 billion market and Woolies thought it could crush the remaining small fish by providing a better retail experience, cheaper prices and a greater range.

This wasn't pie-in-the-sky thinking. US home improvement giant Lowe's has 1840 stores generating $US56 billion in annual revenue and wanted a slice of the action. Why go on a tiny Australian adventure if it wasn't going to make good money on it?

Well, it looks like the dream is over. A flawed roll out and growing pains, to say nothing of the poor locations Masters has been left with by Bunnings, have turned opinion against the venture.

Magellan's Hamish McDonald wants Woolies to 'get those albatrosses off their plate' and Deutsche Bank analyst Michael Simotas thinks there are 161 million reasons to wind up Masters. New chairman Gordon Cairns, who has said "the numbers will determine the decision", might agree.

Without any institutional support, the company appears on the verge of dumping the $2.2 billion invested in the chain, allowing it to concentrate on turning around its supermarkets operation.

That could be a smart decision – Masters is small beer and the company has enough problems on its plate without this one – but when a consensus of this sort emerges it usually pays to examine the counter-argument.

The first of four points against a closure is that Masters might not have been around for long enough for the numbers to reveal much at all.

Retailing is difficult. It takes time to get the model right and adapt to changing conditions. Bunnings dominates with sales of almost $10 billion while Masters turns over just $900m. It might be premature to conclude it's a failure just yet.

Second, whilst Woolworths has admitted it got Masters wrong at the start, stocking unpopular products, underestimating seasonality and setting too ambitious a budget, it is improving.

All companies make mistakes; the question is whether they learn from them. After refurbishing its early format stores, sales have risen 30 per cent. Analysts have said an increase of 50 per cent-100 per cent is needed to break even but who's to say that won't happen in years to come?

Third, major shareholder Lowe's seems unconcerned. In a recent earnings call chairman Robert Niblock said he was "very impressed with the progress that I see the team making down there" – hardly the words of a disgruntled investor wanting out.

Fourth, let's imagine that Masters is shut down and that in a few years' time the market obsession has moved from dividends to growth. Will those same analysts now demanding its closure be clamouring for a growth engine, the kind of thing that Masters could in time become? And what might Woolies do then to satisfy these calls – open a new supermarket chain in Indonesia perhaps? Shareholders might want to be careful what they wish for.

If our investments are to grow over time so must the businesses in which we invest. We should encourage businesses to take sensible risks. We should also accept the possibility of their failure but allow them the time to prove themselves. Woolworths doesn't appear to be getting that chance.

Former chairman Ralph Waters believes that "some years down the track [Masters] will be a thriving business and people will look back and wonder what all the news was about."

He may well be right. If a company is to waste a truckload of money, at the very least investors should demand proof that the original investment offers no prospect of being recovered. Masters doesn't appear to be at that point just yet. Woolworths should resist the pressure and give it more time until we know for sure.

Disclosure: The Intelligent Investor Separately Managed Accounts own all of the shares mentioned in this article. Staff, including the author, own many of the stocks mentioned.