Wesfarmers buys in Britain

'Wesfarmers will almost certainly make another major acquisition at some stage', we said in Wesfarmers counts on Chaney from 8 Dec 15 (Hold – $38.66). As management had been making noises about expansion internationally, there was a strong chance it might be overseas.

Today shareholders discovered what Wesfarmers had in mind. If truth be told, it was something of a relief. Rather than opt for the high growth but risky option of Asia, the company has settled on a beachhead in a relatively mature English-speaking market.

Wesfarmers has made a conditional offer to acquire UK retailer Homebase for about $A700m from Home Retail Group plc. It's not a done deal just yet, as it must be approved by Home Retail Group's shareholders. Grocery chain Sainsbury's recently made a takeover offer for Home Retail Group too, although apparently it only wants the Argos chain.

Homebase is a struggling home improvement retailer, with a merchandise offer that's more homewares and decoration than the do-it-yourself and trade focus of Wesfarmers' Bunnings. Homebase's merchandising strategy looks somewhat muddled so it's perhaps not surprising the chain is underperforming and barely profitable. It has closed almost 20% of its stores over the past two years.

Cheap acquisition?

The acquisition looks cheap, however, with Wesfarmers acquiring the second-ranked home improvement retailer in Britain for a price of less than 0.25 times sales (which total about $A3bn). It will however pit Wesfarmers against British home improvement leader B&Q (owned by Kingfisher plc), which has sales of around $A7bn. Clearly the UK home improvement market is in worse shape than Australia, as B&Q is also closing stores.

Wesfarmers plans to re-launch and re-brand Homebase as Bunnings over the next three to five years. Presumably it will shift the merchandise offer closer to 'do-it-yourself' as well.

There are obviously risks with expanding into a new market – as the Woolworths/Lowes joint venture has discovered with Masters. But Homebase is clearly crying out for much more focused management. Even if Wesfarmers fails, the acquisition won't break the bank. If it succeeds, Homebase could be worth multiples of its purchase price.

We're not thrilled by the idea of overseas expansion but we can at least understand why Wesfarmers has bought Homebase. It will take time to turn around but there's probably a lot of 'low-hanging fruit', as the saying goes.

A $700m acquisition is not particularly large for a company with a $45bn market capitalisation, so it doesn't affect the valuation materially. With the share price barely changed since 8 Dec 15, the stock remains a HOLD.