Woolworths finds itself in a hardware quagmire

Woolworths has admitted it was optimistic about its Masters hardware hopes and - worse - it's now up against a Wesfarmers firing on more than one cylinder.

It is a measure of how concerned Woolworths has been about the market’s speculation about the performance of its fledgling Masters’ hardware business that it rushed out revised guidance today, in the process confirming that a sceptical market got it right.

Woolworths, conceding that its budgets for the hardware business for 2012-13 were too optimistic, revealed that, where the Master’s business was forecast to lose $119 million this year and the associated Danks business to make a profit of $38 million, Masters had lost $157 million and Danks had earned just $18 million.

Overall the hardware business, owned two-thirds by Woolworths and a third by the US retailer Lowe’s, lost $139 million compared with the forecast loss of $81 million.

Woolworths has said in the past that it would take five years for the business, which opened its first store in 2011, to be built and be profitable. It said today that it was confident that it remained on track to be a business that will be built in the first five years "and deliver returns in the following years".

It is still forecasting Masters will break even in 2016, saying that the forecast assumes moderate growth in sales per store, improvements in gross margin as its sales mix stabilises, efficiencies in store and increased fractionalisation of costs in the distribution and support network as sales increase.

It also said, however, that short term results would continue to vary but it expected losses in 2013-14 "not to exceed" this year’s level.

There are analysts who believe the Masters business will still be losing heavily in 2016 – with some predicting losses of more than $250 million in that year.

Woolworths blamed the blowout in Masters’ losses on the overly optimistic sales budgets, relatively higher wage costs for new stores and lower gross margins due to the sales mix. It said it had made adjustments to costs and gross profit mix.

Lowe’s has a put option over its equity in the joint venture, which has been extended for 12 months to October next year.

Despite the Masters’ losses and lower-than-expected Danks contribution, Woolworths’ revised guidance for f 5-6 per cent growth in group earnings of continuing operations, excluding significant items, is slightly firmer than the previous range of 4-6 per cent growth.

It remains to be seen whether Woolworths badly miscalculated when it decided, in 2009, to enter the hardware sector and take on the industry leader, Wesfarmers’ Bunnings.

At the time Woolworths was dominating the food and liquor sector, with Coles’ only just embarking on the remarkable and continuing turnaround achieved by Ian McLeod and his team. Kmart was also struggling and the Wesfarmers’ retail businesses would have looked vulnerable.

Strategically, it would have appeared compelling to attack Wesfarmers’ star retail business – the high-margin, high-returning Bunnings – while Wesfarmers appeared vulnerable and undermine its capacity to support the investment in the attempt to revitalise Coles and its sibling brands.

The rapid resurgence of Coles, the hockey-stick performance of Kmart under Guy Russo, Woolworths' own complacency and the difficulty of being the second and late entrant into a big box hardware market where Bunnings had already staked out the most attractive sites and developed a highly effective and efficient model meant that the context within which Woolworths developed its strategy has shifted dramatically, as has the general climate for retailers across the board.

It hasn’t helped that Bunnings saw it coming and accelerated its own network expansion strategy and refined its offering in the knowledge that the Masters’ format would borrow from Lowe’s offerings in the US. 

Master’s has been positioned upmarket of Bunnings, which presumably means higher in-store costs/lower sales density for stores on sites that would also, presumably, have cost more to acquire than those Bunnings has put together over several decades.

Its own supermarket business has been forced to respond to Coles’ initiatives, its Big W discount department store business has been impacted by Kmart and the tough environment for non-food retailers and the chief executive at the time Woolworths committed to the Masters’ strategy, Michael Luscombe, has been replaced by Grant O’Brien.

Woolworths has, so far, opened only 31 stores on its way to an eventual network of 150 stores and a commitment by the joint venture that could reach $2 billion. It has 120 "active" sites at present, which provides an indication of how deeply committed it now is to the rollout.

An issue for Woolworths, and a target for the criticism of the hardware strategy, is that its own performance and returns over a long period have been so impressive that investors are wary of anything that would dilute them – and a five-year, multi-billion plunge into a new segment would have been a drag on the group’s returns even if it ultimately produced the results Woolworths’ envisaged.

Any hiccup – and today’s announcement of far bigger losses than Woolworths had anticipated at this stage was a significant hiccup – will confirm those concerns. It wasn’t a surprise that Woolworths’ share price got belted this morning and was down about 2.5 per cent.

There was a tidbit of goods news in today’s update. Last year Woolworths virtually gave its troubled Dick Smith electronics chain to private equity group Anchorage Capital for $20 million after writing more than $400 million off the value of the business. It did, however, retain some exposure to any upside.

Today it said it had released Anchorage from that agreement to share some of the upside in return for a $50 million payment late last month and another $24 million payable in monthly instalments from this month. That will bring the overall sales proceeds to $94 million.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles