Woolies: Forget Masters, it's all about the supermarkets

Back in 2009, we expected Wesfarmers to win the hardware battle. Six years later Woolworths has conceded defeat and will now ‘pursue an orderly prospective sale or windup of the [Masters] business’. Woolworths’ home improvement experiment is at an end.

Woolworths will purchase the 33% stake in Masters owned by Lowes, Woolworths’ joint venture partner in the business. It’s not yet clear how much Woolworths will pay Lowes. That will require an independent expert’s valuation. The liability is valued in Woolworths’ accounts at $887m, which implies Masters’ fair market value is almost $2.7bn.

That was based on a ‘going concern’ basis but it’s difficult to see the company paying anywhere near that. As part of the exit plan, Woolworths is also reviewing the value of the business and it will probably report a $1bn-plus writedown in its February interim results.

Once Woolworths owns 100% of the Masters business, it will be better placed to dispose of the assets. It will also have full access to the tax losses generated, which it will be able to utilise over a number of years.

While there will be a cost involved in the (likely) windup, Woolworths should be able to salvage some value. Masters owns more than half its sites, and the recent boom will have helped its property values.

Bunnings will probably be a contender for some of the leases, as it won’t want them falling into the hands of another potential competitor. And the joint venture also owns Home Timber and Hardware, which is profitable and which chairman Gordon Cairns said would be put up for sale.

Most importantly, the sale or windup will eventually remove more than $250m of annual operating losses (now being incurred by the joint venture). The cash Woolworths has been throwing at Masters can be directed towards its supermarkets business, which is what this closure is all about.

It will all take time, of course. Cairns stated the purchase transaction itself would take at least two months, and it will probably take a year or more to wind down the Masters business. A buyer for the entire business is possible but unlikely.

So why did Woolworths make the decision now? After conducting a review that began in September, the board decided it no longer wanted to incur many more years of losses. It also removes the responsibility from the new chief executive. When he or she commences, they can immediately concentrate on the core supermarket business.

The closure of Masters is one of the tough decisions Woolworths needed to take, so it’s pleasing to see the new chairman getting on with the job.

Yet Masters was, in the scheme of things, only a minor irritant. We had already factored its closure into our base valuation case. The more important issue remains how soon Woolworths will be able to regain the trust of its supermarket customers. The evidence suggests more time is needed.

So we continue to expect more bad news from the supermarkets business, including weak same-store sales for a time. There’s a good chance we’ll see a better buying opportunity yet.

Disclosure: Staff associated with Intelligent Investor may own shares in the companies mentioned.