Supermarkets remain the powerhouse
Wesfarmers can't do anything about coal prices, though, and the two bad results were counterbalanced by three very good ones, and a $579 million capital return sweetener.
Coles supermarket chain boss Ian McLeod turned 5.2 sales growth into a 13.1 per cent rise in EBIT to $1.5 billion, boosting the chain's return on capital from 8.7 per cent to 9.5 per cent in the process.
Under McLeod's leadership Coles' return on capital has risen by 4.4 percentage points in the past five years. It has lifted EBIT by $750 million and expanded its EBIT-to-sales margin by 1.9 percentage points, to 4.9 per cent. It is now only about a percentage point short of covering its cost of capital for the first time since it was acquired along with Target, Kmart and Officeworks in Wesfarmers' $18 billion takeover of Coles Group late in 2007.
Bunnings boss John Gillam meanwhile continues successfully to meet the hardware market attack by Coles and its Masters chain. Bunnings boosted EBIT by 7.5 per cent to $904 million on 7 per cent higher sales of $7.66 billion during the year. Its retail league table-topping EBIT-to-sales margin of 11.7 per cent will probably fall a bit this year as Gillam accelerates store openings to meet the Masters invasion, but he's got room to move after holding the chain's return on capital employed at an impressive 25.9 per cent in 2012-13.
Kmart managing director Guy Russo would also have earned KPI points after posting a 28.4 per cent jump in EBIT to $344 million. The discount chain's EBIT margin rose from 6.6 per cent to 8.3 per cent, thrashing a 5.3 per cent margin reported in the December half by its biggest competitor, Woolworths' Big W chain, and its return on capital jumped from 18.9 per cent to a very solid 25.9 per cent
Kmart has posted double-digit EBIT increases for four successive years under Russo's leadership. When Wesfarmers launched the Coles takeover, it wasn't sure it would keep Kmart. The returns Russo is achieving make it a definite keeper.
But Coles' EBIT is more than 4½ times bigger than Kmart's, so it is McLeod's renovation of the Coles supermarket franchise that is having the most impact.
Wesfarmers bought Coles, Officeworks, Kmart and Target just as the global crisis was expanding, and there was widespread scepticism about its ability to invest heavily enough to renovate the tired supermarket chain.
McLeod built his career with the ASDA supermarket group in Britain and took over at Coles in May 2008. Within a year he had begun to demonstrate that the change Wesfarmers boss Richard Goyder wanted was possible, on the budget that Goyder was setting.
On Thursday Goyder agreed with analysts that a lot of the low-hanging fruit had been harvested at Coles, and a 1.6 per cent fall in Wesfarmers' share price partly reflected that sentiment. However, McLeod has renovated only half of Coles' 750 stores - he is moving at a rate of about 100 stores a year - and he is boosting profit margins by adding home brands and extracting supply-chain efficiencies. He says he is confident profit growth will outstrip sales growth for years to come.
He will be telling his team there's a way to go. Coles' 9.5 per return on capital is almost twice as good as it was five years ago, but it compares with a 40 per cent return on funds employed for the Woolworths supermarket division, Coles' biggest competitor.
McLeod has profit momentum, and the return-on-capital gap partly reflects the fact that Woolies marked the entire Coles business up to pre-global crisis market values with its 2007 takeover.
The long-term task is to get Coles up to a 20 per cent-plus return on capital employed, and McLeod's EBIT-to-sales benchmark is also set by Woolies. It posted a 6.9 per cent EBIT-to-sales margin in its supermarkets in the December half.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
Supermarket businesses — mainly Coles — delivered the strongest results in Wesfarmers' portfolio. Coles posted sizable EBIT growth, while retail chains Bunnings and Kmart also produced strong profits. Those three upbeat results helped offset weak performances at Target and the resources division, keeping the group on overall solid footing.
Coles grew sales by about 5.2% and turned that into a 13.1% increase in EBIT to roughly $1.5 billion. Its return on capital rose from 8.7% to 9.5%, and its EBIT-to-sales margin expanded to 4.9% — up 1.9 percentage points over five years. Overall, management has lifted Coles' EBIT by about $750 million during that period.
Ian McLeod has renovated roughly half of Coles' 750 stores (at a pace of about 100 stores a year), added own-brand products and extracted supply‑chain efficiencies. He says he expects profit growth to outstrip sales growth for years to come. The long-term task cited in the article is lifting Coles toward a 20%+ return on capital employed.
Bunnings boosted EBIT by 7.5% to about $904 million on 7% higher sales of $7.66 billion. Its EBIT-to-sales margin was a market-leading 11.7% and its return on capital employed was around 25.9%. The article notes the margin may fall slightly as Bunnings accelerates store openings to meet the Masters invasion, but it has room to manoeuvre given current returns.
Kmart posted a 28.4% jump in EBIT to about $344 million, with its EBIT margin rising from 6.6% to 8.3% and return on capital improving to about 25.9%. Kmart has delivered double‑digit EBIT increases for four successive years under Guy Russo, and those strong returns convinced Wesfarmers it should keep the chain after the Coles takeover.
Target and the resources division were the weaker spots. Target's EBIT slid about 44% to $136 million, indicating a long restoration task. The resources division posted a 66% fall in EBIT to $148 million as coal prices fell — a market factor Wesfarmers can’t control.
The weak performances at Target and in resources were counterbalanced by strong results at Coles, Bunnings and Kmart. The group also returned $579 million of capital to shareholders as a sweetener. Management acknowledged that much of the 'low‑hanging fruit' at Coles has been harvested, which partly contributed to a modest share price pullback.
Coles' return on capital was about 9.5%, versus roughly a 40% return on funds employed for Woolworths' supermarket division — a large gap. Woolworths also posted a higher EBIT‑to‑sales margin (about 6.9% in its supermarkets for the December half), which sets a benchmark for Coles. For investors, this highlights both the progress Coles has made and the scope for further improvement if management can continue lifting margins and returns.
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