Hammering home a Woolworths warning

The latest result from US giant Lowe's raises questions about whether the group is a suitable partner for Woolworths in its ambitious hardware thrust.

Crikey

Did Woolworths pick the right company when it chose US group Lowe's Cos (known as Lowe's) to be its partner in its $1.5 billion plunge into hardware? With Woolworths due to report its full-year profit on Thursday, the question arises after a less-than-stellar second quarter for Lowe's as it struggles to introduce a new retailing strategy that boosts online activity over bricks-and-mortar operations.

Woolies' move into hardware, taking on Wesfarmers chain Bunnings, has been controversial with local analysts and investors, some of whom see the price tag as a waste with the money redirected to price cuts and other measures to counter the successful (so far) challenge from rival Coles. The latest quarter report from Lowe's in fact raises a few questions about whether the US group is suited to partner Woolies in such an ambitious project at a time when its own turnaround is stumbling.

Both Woolies and Lowe's are rapidly expanding the Masters hardware business by building new outlets across the country; in the year to June sales jumped nearly 25 per cent to $828 million as more stores opened. Woolies management has said the business will take four years to start generating profits – so, late in 2013. Bunnings reported a 4.9 per cent rise in operating profit to $841 million, which is just short of that sales figure for the Masters chain.

For Lowe's, main rival Home Depot is doing better and taking share at a time when the recovering housing industry should be benefitting both giants. Lowe's' second-quarter results overnight revealed the company's change of strategy is proving harder to implement than previously thought. Sales growth slipped, profits fell and the company was forced to cut its full-year forecasts.

The confusion caused by the change of strategy has damaged Lowe's' standing with consumers who should be spending more. While the new online strategy, fewer stores and a pricing and product revamp is all supposed to boost margins, they still fell in the latest quarter and might not improve for another year.

To reverse that, Lowe's is trying to imitate copy Home Depot's "everyday low prices" approach. That is one of the staples of retailing around the world, but it continues to amaze how many chains move away from it, stumble and then return seeking salvation at the sales and profit lines in their accounts. Kmart has gone down this route in Australia and was the most profitable department store chain in the 2011-12 financial year. Like so many US retailers (Wal-Mart, Best Buy, JC Penny, etc) Lowe's has been forced to move to an everyday-low-price strategy by the impact of the recession and slump in the US economy in the past five years.

Many of the benefits for Lowe's from its change will come from suppliers, that and and cutting staff, store numbers and improving its internal logistics. It is negotiating with its vendors to improve its product lines and pricing by reducing purchase and selling costs. But Lowe's' management says the company underestimated how long it would take for customers to respond to improvements and for gross margins to fully reflect cost reductions. Like JC Penny – which saw sales fall 21 per cent in the latest quarter and a huge surprise loss reported – Lowe's is finding that once you condition customers to one-off sales and deep discounts, it's very hard to get them to change those expectations.

And like so many other big retailers in the US and elsewhere, Lowe's is investing significantly in e-commerce; shoppers will be able to order online and then pick it up at their nearest store. That's similar to what a host of other retailers are doing, especially Tesco in the UK, Wal-Mart, JC Penny and Best Buy.

Late last year Lowe's closed 20 US outlets and halved its annual expansion plans to around 10 to 15 new stores as it tries to meet the pressures from weak demand and expectations of more to come. Other retailers – Best Buy and JC Pennys, for example, and Wal Mart and Tesco, the world's first and third biggest retailers, are going down this route.

But not in the Masters partnership in Australia, where most of the $1.5 billion is going on property and buildings for the new stores, at a time when the internet is increasing its presence in the sector – even here.

According to US media reports, Lowe's chairman and chief executive Robert Niblock expressed frustration that the new strategy was proving harder to implement than first thought. Second-quarter profit fell to $US787 million from $US830 million a year ago as the cost of the revamp and the weak sales took their toll. Not the best of stories for Woolies to sell to nervy local analysts this week.

Home Depot meanwhile is seeing rising sales from its steady-as-she-goes approach of "everyday low prices" and has caught the rebound in the US home building industry higher. Lowe's has missed that bus and is now ensnared in its strategy revamp which now won't be fully in place until the middle of next year.

US analyst Brian Sozzi, chief equities analyst for NBG Productions, was reported by MarketWatch as telling clients: "I continue to believe the housing sector improvement is not strong enough to support solid sales for both home improvement chains, and think this report from Lowe's only bolsters the case for Home Depot, which I continue to view favourably".

He could be writing that about Australia, where Masters will have its work cut out taking profits from Bunnings. With Lowe's grappling with its transformation, you'd have to wonder if the company will be able to focus its best efforts on its Masters partnership with Woolies. It makes you wonder if Woolies pulled the right rein in picking Lowe's to partner it on its riskiest retailing play so far.

This story first appeared on www.crikey.com.au on August 21. Republished with permission.