Woolworths’ Masters plan running out of time

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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Private sector plea to build more roads

Scott Charlton says governments are more willing to listen to proposals from the private sector. Photo: AFRTransurban chief executive Scott Charlton has called on governments to allow the private sector to build more roads, arguing governments should not be the default provider of new infrastructure.

”It makes sense to test the private sector,” Mr Charlton told Fairfax Media. ”Just because we might have a windfall gain from the privatisation of poles and wires doesn’t mean the government is best placed to deliver [infrastructure] on the other side.”

Mr Charlton’s comments were made to The Australian Financial Review’sBOSS magazine.

The NSW and Queensland governments are planning to privatise their electricity transmission networks, raising billions of dollars to spend on roads and other infrastructure. Typically, governments oversee the construction of new networks, such as NSW’s $11 billion WestConnex motorway.

Construction of the road is due to start in 2015 and the government is considering bids from local and international contractors.

But Mr Charlton said private companies, such as Transurban, which owns toll roads in Australia and the US, could build roads more efficiently.

As well as managing toll roads, such as Melbourne’s CityLink and Sydney’s Hills M2, Transurban is building a new road for the NSW government, the $3 billion NorthConnex tunnel that will link the M2 and F3 freeways.

Transurban struck a deal with the NSW government to build the road after approaching it in 2012 with an unsolicited proposal. Transurban and the government formed a working group to progress the proposal and a final deal was struck in March.

Governments are becoming more willing to listen to proposals from the private sector, Mr Charlton said.

”In the past, there always seemed to be a wall with the private sector – we will tell you what we want, when we want it and you will respond to that,” he said. ”Now there are more people in government who are open to sitting down with the private sector and having a dialogue.”

Mr Charlton has also called on governments to be more open with the public on what proportion of taxes are devoted to roads and how much roads cost to build and maintain. ”The funding model is effectively broken,” Mr Charlton said.

Transurban’s proportional toll revenues – which measure revenues relative to ownership stakes in its toll-road assets – rose 11.8 per cent in the quarter ending in June to $286.7 million.

Proportional revenues for the full year to June 2014 increased 12.6 per cent to $1.1 billion. Transurban’s shares rose 3¢, or 0.4 per cent, to $7.58.

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Fed flags end

The US Federal Reserve plans to stop adding to its bond holdings in October, a sign of its confidence that the economy is gaining strength even as the central bank gradually withdraws its support.

The decision, described in an account of the Fed’s most recent policymaking meeting in June, signals the end of one of the central bank’s most aggressive efforts to stimulate the US economy. The Janet Yellen-chaired Fed, which started reducing its monthly purchases in January, said it planned to add a final $US100 billion to its holdings of Treasuries and mortgage-backed securities over the next four months, for a total of $US1.5 trillion.

But the account underscored that many Fed officials remained guarded in their optimism about the economy. It also suggested they had not yet decided when to take an even more important step in their retreat: raising short-term interest rates for the first time since December 2008.

Uncertainty over US interest rates helped drive the Australian dollar back above US94¢ after it was sold off heavily last week on comments by Australia’s Reserve Bank that the currency was overvalued. The Australian dollar has remained elevated for much of this year, as historically low interest rates and Australia’s triple-A credit rating have supported riskier currencies.

US investors generally expect the Fed to start raising interest rates next summer. It said the decision to end bond purchases in October, rather than continuing purchases at a nominal level until the end of the year, should not be interpreted as evidence that rate increases were likely to begin sooner.

”Most participants viewed this as a technical issue with no substantive macro-economic consequences and no consequences for the eventual decision about the timing of the first increase in the federal funds rate,” the minutes said, referring to the benchmark interest rate the Fed uses to influence borrowing costs for consumers and businesses.

Federal Reserve officials disagree about the pace of retreat in large part because they disagree about how much more monetary policy can accomplish. Five years past the end of what is known as the Great Recession, the share of adults with jobs has barely recovered, inflation remains below the level the Fed regards as healthy and economic output remains weak.

But since last year they have been in firm agreement that the time has come to stop buying bonds.

The purchases are intended to reduce borrowing costs for businesses and consumers and to encourage risk-taking by investors.

But the impact of the Fed’s asset purchases remains highly contentious. Officials and academics disagree about how much, if at all, the purchases have reduced the cost of mortgages and other kinds of consumer and business loans. They also disagree about the consequences.

New York Times

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Fairfax Domain pays $50m for the ACT’s Allhomes

Fairfax Media’s Domain Property Group has agreed to pay $50 million for Allhomes, the leading real estate marketing website in Canberra.

Allhomes serves more than 180 real estate agencies in the Australian Capital Territory and the brand will be retained, operating in tandem with Domain in the market.

”I think it does make sense for Domain, given there are big synergies in that sort of business because you just put it onto your website,” said Simon Marais, managing director of Allan Gray, which owns 5.7 per cent of Fairfax. ”I guess there is not a big cost in doing that but, of course, you should never pay too much for an acquisition.”

It is believed the $50 million price tag reflects a multiple of less than 10 times earnings before interest, tax, depreciation and amortisation.

Fairfax, which owns The Age and The Sydney Morning Herald, was advised by PwC, while Allhomes was advised by Origin Capital Group with legal advisers Connor Stevens and Meyer Vandenberg.

Allhomes, a private company majority owned by the Blackshaw real estate family, is thought to have spurned an offer from utility joint venture ActewAGL about three years ago.

Domain chief executive Antony Catalano said the Allhomes acquisition was very important for Domain.

”Allhomes has been a strong operator in the Canberra market for 14 years and is the go-to destination for all property buyers and sellers in the ACT,” he said.

Fairfax also owns a national radio network and metropolitan newspapers but, given the structural issues in print, Domain has quickly become the company’s trophy asset. The property business generated earnings before interest, tax, depreciation and amortisation growth of 33 per cent to $29.4 million for the six months ended December 31.

Mr Catalano has moved quickly since taking the helm of Domain last year, spending $80 million in acquisitions, rebranding the company and hiring 100 new staff.

One leading analyst said the Allhomes acquisition would initially add about $3 million to $4 million a year to Domain’s EBITDA.

”This is a sensible acquisition for the company,” the analyst said.

Fairfax shares closed 3.3 per cent higher at 94¢ on Thursday.

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Indonesia’s role will grow: PM

Prime Minister Tony Abbott says Indonesia will play an increasingly important role in global affairs and predicts his government will be able to work with whoever is elected the new president of the vast archipelago.

As counting continues in the election and Joko Widodo firms as the likely victor over Prabowo Subianto, a cautious Mr Abbott praised both men as ”competent, credible individuals who will do their best to build a better and stronger nation”.

The Prime Minister steered clear of the controversial hardline asylum seeker policies enacted by his government.

”Both of them [Mr Joko and Mr Subianto] are on the record as wanting to maintain good and strong relations with Australia. I’m confident we will always be able to work well with the Indonesian president,” he said.

”Whoever ultimately emerges, we will be able to work with them.”

Asked if China’s inclusion of waters near Indonesia’s Natuna Islands in the so-called ”nine-dash line”, which denotes that nation’s territorial claims, could draw Indonesia into deeper regional engagement with Japan, the United States and Australia, Mr Abbott chose his words carefully.

”I think Indonesia will play a larger part in regional and world affairs and I think Indonesian will be very keen to try to ensure that all countries operate in accordance with the precepts of international law,” he said.

After the visit by Japan’s Prime Minister, Shinzo Abe, Mr Abbott also said it was false to suggest Australia must choose between lining itself up with China or the US and Japan.

He also endorsed the tough stance of his deputy, Foreign Minister Julie Bishop, who told Fairfax on Wednesday that an increasingly strident China did not respect weakness.

”No countries respect weakness. I mean East Timor, let alone China, doesn’t respect weakness so I think she was just stating a commonsense position,” he said.

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