Bunnings nails down a growth plan

Bunnings' expansion won't stop Masters forging ahead in the looming hardware wars, but it will make it hard for Masters to gain any competitive advantage.

Today’s announcement by the Wesfarmers-owned Bunnings hardware group that it plans a $1.5 billion expansion of its 200-store network could be seen as an escalation of the chain’s efforts to contain the threat posed by Woolworths’ nascent Masters business. In fact the escalation occurred some time ago.

Bunnings said today, ahead of the formal opening of its 200th store, that it plans to build up to 85 new stores in what would appear to be – and is – a major expansion program. In effect, however, the announcement simply articulates a program that is already in place – Bunnings has been opening 15 or 16 stores a year in recent years and made it clear that it would continue to expand at that same rate into the medium term. At December 31 it had 16 stores under construction.

What the announcement does do is put the 'battle' between Bunnings and Masters into perspective.

Woolworths has said it plans, with its US partner Lowe’s, to open 150 Masters stores over five years at a cost analysts estimate will be between $3 billion and $4 billion. It currently has eight stores operating, with another 17 or 18 under construction, and says it has more than 100 sites in its pipeline.

By the time the Masters chain gets to its 150-store target, Bunnings will have close to 300 stores – it will still have a massive advantage in scale and incumbency to offset whatever buying power Lowe’s provides Masters.

Where the Woolworths’ expansion into hardware will lose money, and lots of it, until it achieves critical mass, Bunnings’ expansion brings with it incremental earnings.

Bunnings’ John Gillam knew Woolworths was coming into his sector before Masters was officially launched and did two things.

He stepped up the pace of its network expansion – particularly in New South Wales, where for historical reasons Bunnings has been under-represented – and he also overhauled his offering and store presentation, at some cost to earnings and returns on capital. Nevertheless, Bunnings is still generating a return on capital nudging 30 per cent and earnings before interest and tax that produced a margin of just under 13 per cent on sales in the December half.

Masters was conceived during the period when Woolworths’ food, liquor and Big W businesses dominated its main rival, Coles. Since Coles and its sibling brands, Target and Kmart, were acquired by Wesfarmers, however, there has been a major resurgence by Coles and Kmart and, of course, a major downturn in the retail sector that has hurt Target and Big W.

For the first time in a very long time it is Woolworths that is having to respond to Coles and also to Kmart, which has adopted an extremely disruptive but so-far successful retail strategy that has impacted Big W adversely at a time when discount department stores generally are under significant pressure from the economic conditions.

The grocery wars are, of course, having broader effects in the sector and its supply chain. Today Metcash shares were placed in a trading halt as that group, caught in the crossfire between the grocery giants, considers whether it needs to take some impairment charges.

Woolworths still has significantly better financial metrics than Coles but Coles is growing at a materially faster rate and has substantial latent improvement left in a business whose renovation is far from complete.

The Masters hardware strategy, designed to create pressure on Wesfarmers’ best retail business while it was trying to renovate a supermarket business that had historically chronically under-performed, is now starting to depress Woolworths’ returns at a point where the market is imposing pressure on it to improve its performance and focus more on its returns on capital than simple growth.

The hardware wars that are looming as the Masters’ rollout continues aren’t necessarily a zero sum game. The sector is highly fragmented and it is a growth sector, so both chains – and the Metcash-backed Mitre 10 brand – could grow profitably without having to grow at one or another’s expense.

There are, however, bound to be some collisions – big box formats require big catchment areas and both chains will have stores with overlapping catchments.

Bunnings, however, will have its established network and operating experience, its established brand and its substantial scale advantage, which means it will be difficult for Masters to gain any meaningful competitive advantage and even more difficult for it achieve returns approaching those Bunnings has historically enjoyed.