Woolies' expansion toolbox

Wesfarmers has known for a long time that the metrics of its Bunnings hardware chain were too tasty for the expansion-hungry Woolworths to resist. With a bid for Danks Holdings and a joint venture with US hardware group Lowe's, the expected assault on the Wesfarmers stronghold is underway.

There were numerous obstacles to Woolworths' entry to the sector. One was the absence of a 'big box'' format rival to Bunnings to acquire as a platform, another was a shortage of sites suitable for 10,000 square metre-plus warehouse-style stores, but perhaps the biggest was Woolworths' lack of expertise in hardware retailing.

Woolworths dallied with the Mitre 10 co-operative but found the structure too difficult and the stores too small for its purpose. It has also spent considerable time talking to US hardware executives and chains looking to acquire the executive team to spearhead its expansion.

In the end, its solution is creative and lateral. Danks is a major distributor of hardware, supplying the Home Timber & Hardware, Thrifty-Link and Plants Plus retail networks. The $88 million agreed bid, if successful, would instantly give Woolworths a hardware supply chain. The joint venture with Lowe's will give it access to the management expertise.

Woolworths saw the financial crisis as its opportunity to gain a beachhead in the sector because it has made prospective sites available on reasonable terms, although it won't be easy for the group to secure sites in strategic locations because of the massive head start Bunnings, with 175 warehouse stores, 56 smaller stores and 22 trade centre – and more than a dozen under construction – has established.

Woolworths has been scouring the country for sites. It says it has a foot on 12 sites, is in final negotiations for another 15 and plans to secure more than 150 sites with potential for 10,000 square metre-plus stores within five years. It says its first store will open in late 2011.

The joint venture with Lowe's is focused on the new retail business, with Lowe's owning a third of the joint venture and funding its share of the expansion.

Wesfarmers won't be complacent about the threat posed by Woolworths and its partner. From Woolworths' perspective, the move is not only about entering a big and attractive new retail category but also putting some pressure from a different direction on Wesfarmers and its capacity to support the rehabilitation of Coles as a competitive threat to Woolworths in food and liquor retailing.

Bunnings is a fabulous business which dominates, without challenge until now, the big end of the sector. It grew sales 9 per cent last year, to $5.85 billion, and enjoyed a retail margin of more than 11 per cent, returning more than 30 per cent on the capital employed in the business. Its scale, efficiency and category experience means it ought to be able to defend its patch in the near term as Woolworths ramps up its network.

Woolworths has demonstrated, however, that it is an extremely efficient and quite ruthless competitor, and it has the surplus cashflows and balance sheet capacity to underwrite its longer term ambitions. Woolworths said its board and management had allocated ''significant'' funding and resources to the hardware play.

More immediately exposed in a highly fragmented sector are probably the smaller independents and co-operatives, which would be unsettled by Woolworths bid for Danks, despite Woolworths saying that the growth and success of the independents was fundamental to its own success.

Woolworths has been pouring capital into its existing formats to entrench its dominance in food and liquor. It has also been searching for a supermarket acquisition in the US to take advantage of the distress in that market. It is unclear whether the commitment to entering the hardware sector means offshore expansion plans will be put on hold.