Supermarkets remain the powerhouse
A 44 per cent slide in Target's earnings before interest and tax (EBIT) to $136 million in the June year confirms that Wesfarmers has a restoration job of many years on its hand in that business. And the group's resources division is the other dog loose in the stable: it posted a 66 per cent lower EBIT of $148 million as coal prices fell.
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.