A rare admission of Woolworths failure

The restructuring of the Australian retail sector is gathering pace, with the not unexpected announcement from Woolworths today that it had decided to offload its underperforming and under pressure consumer electronics business in Australasia once it has performed radical and expensive surgery on the network of Dick Smith stores.

The decision, after a three month strategic review, was almost inevitable despite some signs that Woolworths has stabilised the business, which generated comparable stores sales growth of 2.4 per cent in the latest half-year, with second-quarter growth of 4.8 per cent.

The category, however, is arguably the worst affected by both the cyclical and structural changes occurring in the retail sector. It is highly exposed to competition from online retailers as well as being impacted by the weak consumer spending, intense competition and the interaction of that competition with the strength of the Australian dollar in driving price deflation and margin pressures.

Last year the Australasian consumer electronics business generated the best part of $1.5 billion of sales but only $22 million of earnings before interest and tax, a retail margin of only about 1.4 per cent. Woolworths' core supermarkets business produced a margin of 6.63 per cent last year.

While Woolworths generally has come under pressure from a resurgent Coles within a difficult environment, criticism of the group has generally related to its performance relative to Coles and its own stellar track record rather than its absolute results, which have held up well in the conditions.

The decision to sell the Dick Smith brand, therefore, represents a rare admission of failure within the modern history of Woolworths.

The reasons for that failure are many and varied but perhaps Woolworths itself identified the core of the problems it has experienced when it said today that the strategic review had concluded that its main strengths were primarily in larger format, multi-channel, high-volume retail segments with market-leading positions.

Dick Smith is profitable and the latest sales numbers are showing growth but it isn't a neat fit within Woolworths' own definition of its strengths and, as the group said, it has been a major distraction to senior management in recent years, attracting a level of investment and attention disproportionate to its importance to the overall group.

Like other major retailers that have shrunk their presence in the sector, Woolworths will in future be able to focus on a narrower product range within its Big W discount department store offer.

There is going to be some pain associated with the exit from the category, with Woolworths saying it will accelerate the rationalisation of its store network, with up to 100 underperforming stores – out of a network of nearly 390 stores – earmarked for closure within two years. The group will take a $300 million restructuring provision as a consequence.

While Woolworths said it had a number of unsolicited approaches since it announced the strategic review, the decision to restructure the business and take the charge against profit itself signals that there hasn't been anything firm and/or acceptable put to it.

While the category is a difficult one, and the structural challenges can only increase, the size of the sales base, the fact that it is profitable and Woolworths' commitment to selling the brand may attract some interest now that the provision will have reduced the book value of the chain to fairly negligible levels.

The string of retail failures, the rethinking of the old retail growth formula of continual new stores openings by most of the major retailers and now the loss of another 100 of the Dick Smith stores will add to the pressure on retail landlords and their rents. That's another structural change occurring within the broader sector.

Woolworths' half-yearly sales numbers that were also released today were quite respectable, with overall growth of 5 per cent (3.7 per cent excluding petrol) and 5.6 per cent growth in the supermarket division's sales.

The key Australian food and liquor business, however, grew sales at a more modest 4.3 per cent and only 1.5 per cent on a comparable stores basis, although there was some improvement (plus 2.5 per cent) in the second quarter.

Big W sales were down 1.3 per cent for the half and on a comparable stores basis 2.8 per cent.

Woolworths said that in both divisions customer numbers and the volume of products sold were up, but both units experienced significant price deflation.

In the supermarket business Woolworths has been forced to lower prices to combat the price-driven competition from Coles, while Big W is caught up in a torrid competition with the full-service and discount department stores and speciality retailers for increasingly price conscious and frugal consumers.