The Masters store in Braybrook in Melbourne.Correction: Elizabeth Knight’s column regarding Masters, “No place like homewares” (July 11), should have included the fact that Lowe’s joint venture arrangement with Woolworths had been extended until October 2015. It should also have said that Woolworths had committed to having 90 stores in 2016, not 150.
Woolworths boss Grant O’Brien is desperate for the market not to declare his home improvement operation, Masters, a man-made disaster but with only three months left before its US joint venture partner, Lowes, gets the opportunity to sell its share to Woolworths it’s clear that time is not O’Brien’s friend.
Woolworths still maintains it can get the home improvement business to break even by 2016 as does the British hardware expert, Matt Tyson, it imported to fix it up. By then it will have notched up five years and should have rolled out 150 stores.
But there remains a credibility gap – not the least of which is because according to figures periodically released by Lowes, Masters’ financial performance appears to be going backwards.
Ratings agency Fitch believes that over the course of the 2014 and 2015 financial years Masters will lose $300 million but is more concerned about the possibility Woolworths may need to pay Lowes up to $800 million to buy its 33 per cent.
Originally this put option was to expire last year but it was extended until October this year and one has to wonder whether Lowes would be willing to further extend it given that the Masters losses continue to mount.
Clearly the creation of Masters has not gone to its original plan – a point made abundantly clear a year ago when management admitted it had made a series of mistakes in its Masters network and Danks hardware wholesaling operations – overestimating sales and gross margins, underestimating labour costs and the impact of seasonality, and getting wrong parts of its product range. Back then Masters director and the mastermind of the strategy, Melinda Smith, told investors Woolworths didn’t know much about the seasonal curves of the home improvement industry and it didn’t have the right stock in some instances.
The investor briefing became legendary due to its embarrassing admissions.
“Labour costs are different in Australia to the US,” she said. “Christmas in the US is in the middle of winter, which is different to Australia.”
It was forced to report that as a result, Masters’ 31 stores lost $157 million in 2013, exceeding Woolworths’ initial forecasts for losses of $119 million, while earnings from Danks fell from a forecast $38 million to $18 million.
Group home improvement losses were $139 million – well ahead of Woolworths’ $80 million guidance – and losses will be similar in 2014.
It appears that the venture lost about $51 million in the April 2014 quarter, up from $33 million in the previous quarter, according to recent analysis by Deutsche which extrapolates from numbers released by Lowes.
The performance to date brings into question the rationale Woolworths employed when it embarked on this venture.
To the extent that it was designed to apply pressure to its arch retail rival Wesfarmers – which owns home improvement chain Bunnings and Coles supermarkets – it appears to have had no impact.
Bunnings’ earnings have improved over the past three years and in its most recently reported quarter sales rose 12.3 per cent.
It hasn’t lost market share and its earnings continue to grow.
Woolworths expected (as per a report it commissioned in 2010) to generate $30 million per store and reduce the revenues of nearby Bunnings and Mitre 10 stores by 16 per cent.
According to Fitch, Masters is instead only generating revenue of $22 million per store and losing $2 million in earnings before interest and tax per store, while Bunnings is generating nearly $40 million per store and earnings of $10 million per store.
Moreover, says Fitch, Bunnings’ like-for-like store sales are growing at about 4 per cent, with Bunnings expected to match Masters’ 20-store rollout in 2014.
As a result the introduction of Masters has not placed any additional pressure on the remainder of Wesfarmers retail operations.
Despite the slower-than-anticipated pick-up in Masters, investors have given O’Brien the benefit of the doubt for a while at least. However if the losses don’t begin to lighten in 2015, their patience may run out.
But like Fitch other analysts have also noted that the placement of Masters’ stores is not as attractive as Bunnings with many rolled out into less densely populated areas rather than more central metro locations. Troubled though it may be – it’s not big enough to make a meaningful dent in Woolworths’ earnings profile.
On key credit drivers Fitch remains relaxed about Woolworths, noting that the combination of being number one in market share in supermarkets and its high proportion of defensive revenues delivers strong investment grade characteristics.
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