Woolworths deserves more time for Masters

Masters was meant to be Woolworths' (ASX: WOW) growth engine, a business that protected it from an over-reliance on its huge supermarkets operation.

Home improvement looked like a great opportunity. In 2011, when the first Masters store opened, Bunnings — owned by Wesfarmers (ASX: WES) — dominated this $42bn market. Like Bunnings, Woolies thought it could crush the small fish by providing a better retail experience, cheaper prices and a greater range.

This wasn't pie-in-the-sky thinking. US home improvement giant Lowe's has 1,840 stores generating US$56bn in annual revenue. Why go on a tiny Australian adventure if it wasn't going to make good money on it?

Well, it looks like the dream is over. A flawed roll out and growing pains, to say nothing of the poor locations Masters has been left with by Bunnings, have turned opinion on the partnership.

Magellan's Hamish McDonald wants Woolies to 'get those albatrosses off their plate' and Deutsche Bank analyst Michael Simotas thinks there are 161 million reasons to wind up Masters. New chair Gordon Cairns, who has said 'the numbers will determine the decision', may well agree.

Not one analyst or commentator thinks keeping Masters is a good idea. The company appears on the verge of dumping the $2.2bn invested in the chain, allowing it to concentrate on turning around its supermarkets operation.

Make no mistake, this is a powerful argument. Masters is small beer, which is why whatever path Woolies takes with Masters doesn't impact our recent upgrade of the stock. But when a consensus of this sort emerges it usually pays to examine the counter-argument.

Counter-argument

The first of four points against a closure is that Masters might not have been around for long enough for the numbers to reveal much at all.

Retailing is difficult. It takes time to get the model right and adapt to changing conditions. Bunnings dominates the home improvement market with sales of almost $10bn while Masters turns over just $900m. It might be premature to conclude it's a failure just yet.

Second, whilst Woolworths has admitted that it got Masters wrong at the start, stocking unpopular products, underestimating seasonality and setting too ambitious a budget, it is improving.

All companies make mistakes; the question is whether they learn from them. After refurbishing its early format stores, sales have risen 30%. Analysts have said an increase of 50%-100% is needed to break even but who's to say that won't happen in years to come?

Third, major shareholder Lowe's seems unconcerned by the weak start. In a recent earnings call chairman Robert Niblock said he was 'very impressed with the progress that I see the team making down there'. These are not the words of a disgruntled investor that's just blown his dough.

Fourth, imagine for a moment that Masters is abandoned and that in a few years' time the market obsession has moved from dividends to growth. Will those same analysts now demanding the closure of Masters be clamouring for a growth engine, the kind of thing that Masters could in time become? And what might Woolies do then to satisfy these calls — open a new supermarket chain in Indonesia perhaps?

More time needed

If our investments are to grow over time so must the businesses in which we invest. We want businesses to take risks and should accept the possibility of their failure. But we need to allow them the time to prove themselves and I'm not convinced that Woolworths has been given that chance.

Former Woolworths chairman Ralph Waters believes that 'some years down the track [Masters] will be a thriving business and people will look back and wonder what all the news was about.'

Let's hope the company resists the pressure from analysts and commentators alike and gives Masters the chance to prove Waters was on to something.

If a company is to waste hundreds of millions, at the very least investors should demand proof that money has been genuinely wasted and offers no prospect of being recovered. Masters doesn't appear to be at that point just yet.

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