Opinion: Wesfarmers’ wayward on Homebase?
Wesfarmers’ venture into the British hardware market has attracted warnings of impairments on its accounts by analysts unconvinced of the wisdom of the move.
The leading critic of Wesfarmers $704 million acquisition of the Homebase chain has been David Errington, an analyst with Merrill Lynch Bank of America.
Errington, who has also been a dogged critic of Woolworths, claims that Wesfarmers could be forced to book an impairment of up to $4 billion on its accounts if it proceeds with its plans to renovate the Homebase business.
Errington argues the company would be better to put its development plans on ice in a move he claims would still result in an impairment charge, potentially as high as $2.5 billion.
The negative assessment of the Wesfarmers venture is based on Errington’s projections of trading losses and capital burn over the next five years.
Errington argues the economic outlook in the United Kingdom bodes poorly for a turnaround in the under-performing Homebase, an outlook that is now clouded by the Brexit decision.
Errington describes Homebase as a subscale home improvement business and believes it will not contribute any earnings to Wesfarmers accounts, effectively dragging down the phenomenal results of Bunnings Warehouse chain that this year vanquished Woolworths Masters Home Improvement business.
Other analysts are also concerned about the acquisition with the UK tipped to go into recession following the Brexit decision and with a predicted price war erupting as chains such B&Q, Wickes, Screwfix, Selco and Took Station defending their market share.
The loss of sales from the closure of Argos and Habitat concessions selling soft furnishings and indoor furniture in Homebase stores has also made some analysts nervous about the immediate, if not the long term, revenue growth and profitability of the chain under Wesfarmers ownership.
Crunching recent financial data, Citi Group analyst, Craig Woolford, calculates the return on capital for Homebase is just 2.2 per cent compared with 34 per cent for the barnstorming Bunnings Warehouse.
Woolford points out that Homebase has the lowest sales productivity of any home improvement business in the world.
Wesfarmers has already begun to overhaul marketing and promotional strategies, moving towards the everyday low prices model that has proved so successful for Bunnings Warehouse.
However, British retail commentators claim the move comes with serious risks to customer engagement with Homebase traditionally driving sales with a promotional discount strategy.
The UK commentators expect Homebase margins to be hit by the pricing strategy change as well as the loss of the in-store Argos and Habitat concessions and they also point out bottom line results will be significantly impacted by restructure costs.
However, Wesfarmers is dismissive of the analysts views, pointing out that it undertook comprehensive research of the UK home improvement market as part of its due diligence on Homebase.
Wesfarmers is bullish on growth prospects and believes it can turnaround stores that the previous owners, Home Retail Group, had decided to close in a bid to improve productivity. Home Retail Group, which acquired Homebase from the Sainsburys supermarket chain in 2006, closed 60 stores before Wesfarmers offered to buy the chain.
Home Retail Group had earmarked 25 per cent of the store network for closure but Wesfarmers has already opted to retain 16 of the next cache of 23 stores that were to be shut by the former owners.
Wesfarmers has several key retail executives working on the Homebase turnaround, two of them with direct experience in rebuilding struggling retail chains.
One of those executives is the highly regard Archie Norman, renowned for his turnaround work as ASDA and for advising Wesfarmers on strategies to revitalise the Coles supermarket chain which was lagging behind Woolworths.
Norman, who is still on the Coles board, was instrumental in recruiting Ian McLeod and a team of UK executives that succeeded in driving the Wesfarmers supermarket chain past Woolworths.
The second key executive is Peter Davis who, with West Australian retailer, Joe Boros, developed the Bunnings Warehouse business model from the platform of a struggling McEwans hardware chain in Victoria.
Davis was instrumental in the early success of the warehouse store model and in the development of a smaller format model suitable for regional markets.
Wesfarmers sees parallels between the McEwans acquisition and transformation and the opportunity of Homebase and Davis has the corporate history associated with restructuring and repositioning a hardware chain and creating an everyday low prices proposition for customers.
The third key executive recruited to Homebase is Matt Tyson, who worked with B&Q, the home improvement market leader in the UK before joining Masters Home Improvement in an ultimately unsuccessful bid to save the Woolworths Lowes joint venture.
Wesfarmers removed the incumbent management at Homebase shortly after assuming ownership, believing that old habits and attitudes would hamper the transformation of the struggling chain.
Wesfarmers is rebranding the Homebase stores to its Bunnings Warehouse banner, just as it did with McEwans, and is set to launch a new format before Christmas to test some of its concepts before rolling out the new store model across the chain of around 25 stores in the UK and Ireland.
A capital allocation of around $1 billion is currently locked in by Wesfarmers for store upgrades and any potential new store locations over the next five years. But the capital funding is contingent on the success of several test stores.
Homebase stores have an average footprint of around 4000sqm which is similar to the smaller store model Bunnings Warehouse created for regional markets.
Wesfarmers plans for the future would envisage big box warehouse stores of 12,000sqm plus which are the backbone of the Australian network. Wesfarmers values the home improvement market in the UK at around $65 billion while Mintel values the market at $25b. Prior to the Brexit decision, the market was forecast to grow by around $1.2 billion by 2018.
John Gillam, Bunnings Warehouse MD, claims Errington and other analysts have used the wrong calculations and assumptions.
Gillam argued at an investor day with Errington and indicated any comparison with the failed Masters Home Improvement chain with the Homebase venture are ill-conceived.
Wesfarmers points out Masters Home Improvement started from scratch, relying on Lowes expertise in the United States market and the Danks wholesale operation that supplied independent stores to develop its concept.
Wesfarmers has acquired an existing business with around 250 stores as a viable platform on which to implement its transformation plans.
Homebase already has a customer base that Wesfarmers can engage in implementing changes within the business and has in place a supply chain.
Notwithstanding the expectation of cost provisions for the transformation, Gillam is also quick to point out that Homebase, while struggling under its previous ownership, is profitable.
Part of the opportunity that Wesfarmers saw in Homebase was the fact it was struggling and lacked direction with Gillam saying the business was not a well run business and had suffered under a decade of poor management.
Gillam said there are significant growth prospects for its UK subsidiary as the two largest players in the market in the highly fragmented British market have a combined market share of less than the 19 per cent slice Bunnings Warehouse commands in the $48 billion Australian market.
Convinced that Homebase has the right sized stores and a well located network with a latent capability for a low cost operating model, Gillam said phase one for the UK management team is a retail basics focus and investment in both the team and core business activities.
Wesfarmers completed the acquisition last February and phase one would run through to early 2017.
For the three to five years from that point, Wesfarmers will develop the warehouse format, expand digital engagement, broaden the choice of brands for the DIY and trade customers and integrate the “best of Bunnings” with essential local elements to build new business and drive sales and earnings growth.
Gillam says the results of the first four months have been encouraging and the turnaround of the business is underway with new marketing and increases to range width and stock depth.
Gillam has also been quick to address investor fears that Homebase will be a distraction to management and will adversely impact on the Bunnings Warehouse business in Australia and New Zealand in the same way Masters Home Improvement dented the Woolworths supermarket business.
Gillam told the recent Wesfarmers analysts briefing the company was pursuing a plan that would provide long term value creation, grow the market and grow the Bunnings Warehouse share of the market.
He said management was focusing on creating better customer experiences, strengthenin its core business with team development, better productivity and improved stock flow and driving stronger growth, in part, through more merchandise innovation.
While Wesfarmers is continuing to expand, Woolworths board of directors will sit down on July 18th to mull over expressions of interest for its Masters Home Improvement property portfolio and business assets and the Danks wholesale operations that supply independent hardware stores, including the Home Timber & Hardware Group.
Metcash, the listed wholesaler that owns the Mitre 10 hardware banner, has agreed to a series of conditions the Australian Competition and Consumer Commission has insisted as part of a determination not to oppose Metcash acquiring the Danks and home Timber & Hardware business.
Metcash argues that a merger of the two hardware supply channels would provide the operational scale to allow independent retailers to successfully compete with Bunnings Warehouse.
Despite Metcash accepting the regulators conditions, the ACCC has yet to indicate its view of the merger proposal leaving Woolworths exit plans from the disastrouos Masters Home Improvement venture in limbo.
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