Woolworths' Grant O’Brien has confirmed what the market anticipated and what shareholders feared. Its attempt to gate-crash the hardware sector and challenge Wesfarmers’ Bunnings Group’s dominance has been a credibility-undermining debacle, with losses from the Masters business continuing to blow-out.
Last year, in disclosing a worse-than-expected Masters’ loss of $157 million, Woolworths said the chain’s losses would be no greater than that year. It 'fessed up to a series of embarrassing blunders in the rollout of its store network (including a failure to recognise that the seasons in Australia are different to those of its North American joint venture partner Lowe’s), and said it would break even in 2016.
Instead Woolworths has been forced to provide a market update that reveals that Masters' losses this financial year have reached $176m, meaning it has lost almost $333m in two years. It has abandoned the pledge that the business would break even in 2016.
With the group’s other timber and hardware earnings plummeting 60.5 per cent from $17.7m (of earnings before interest and tax) to $7m, the hardware strategy resulted in overall losses of $169m in the 2014 financial year after $139m of losses last financial year.
Woolworths and Lowe’s have 49 stores trading and had planned to have 90 stores open by the end of the 2016 financial year. Now they plan to slow the pace of the rollout, opening new stores at a rate of between 10 and 15 a year over the next few years -- or about half as many new stores as originally planned.
With the announcement of the losses Woolworths and Lowe’s also announced a change in the detail of the relationship between Woolworths and its partner.
Lowe’s, which has a one-third interest in Masters, has an option to put that interest to Woolworths. Last year the exercise date was extended by 12 months. Today Woolworths said Lowe’s can now issue a notice setting an exercise date that triggers a 13-month notice period. The new arrangement has no end-date.
It is apparent with hindsight that Woolworths over-estimated its own capabilities and those of its partner while under-estimating the John Gillam-led team at Bunnings, which acted pre-emptively to accelerate its own network expansion and fine-tune its offering ahead of the Masters rollout.
Woolworths thought Wesfarmers was vulnerable in the early phase of the attempt to revitalise Coles and therefore attacked its best retail franchise. Instead the Coles team were successful beyond any expectation, putting pressure on Woolworths’ core supermarket business. In addition, the attack on Bunnings has misfired spectacularly.
The strategy looked good on paper. As O’Brien said today, home improvement is a $45bn growth market, which is highly fragmented. There is only one major player with about 17 per cent of that market.
The problem has been in the execution. Woolworths has previously admitted that it had been overly-optimistic on sales budgets, wage costs and margins and that when it framed its original budgets, it actually hadn’t known much about the hardware market.
It now concedes it made mistakes in the geography of the rollout, adding sites opportunistically as they became available rather than creating a network that optimised supply chain efficiency.
There was always a risk, now evidenced by experience, that such a large-scale entry with such an ambitious rollout schedule would lead to a less-than-perfect and overly-expensive network. Bunnings has had a very long time to establish itself and to get control of the best locations.
There was also a risk, also borne out by experience, that in trying to differentiate its offer from Bunnings by offering a somewhat upmarket store experience with lower stock densities and a range that includes low-margin whitegoods and other homewares, Woolworths wouldn’t attract the hard-core market of tradespeople and DIY handymen (and women) who frequent Bunnings.
Woolworths and Lowe’s are now, for a second time, changing their in-store offering to try to increase customer traffic and conversion rates. Ironically, given that Masters is a hardware chain, Woolworths said it would give more space to hardware.
Woolworths’ defence of Masters’ disappointing performance is that the business is immature, with the 49 stores now operating having been open for an average of only 17 months and with a number of stores in country and regional areas that will take longer to mature.
It says its stores are now expected to take about four years from opening (and longer where they are being cannibalised by other stores in the network) to mature. Nearly a third of the network has been operating for more than two years and it apparent that even the more established stores aren’t generating anything like the sales numbers required for them to break even.
Woolworths did appoint a new managing director for Masters and the wider home improvement business at the start of this year, a UK veteran of the sector, Matt Tyson. Presumably the latest re-jigging of the strategy and offer flows from his assessment of the condition of the business.
With at least another two years of losses now in prospect, the Masters strategy has exposed a lack of competence in a group renowned for its competency as a food and liquor retailer. It seems likely the losses will comfortably top $500m and there will be some continuing doubt over whether it is possible to turn the chain around even beyond that unless Tyson can reduce the rate of loss.
The market and its shareholders may begrudgingly accept the admissions of continuing mistakes and misjudgements (and the losses) to date because of the improved performance of its already high-performing supermarket and liquor core.
Any further bad news on the Masters front, however, will ratchet up the pressure on Woolworths to abandon the hardware strategy and for anyone associated with it and its execution to accept responsibility for its failure. O’Brien needs this to be the last 'surprise' on the downside flowing from the hardware strategy.