Illustration: Kerrie Leishman.Since Woolworths announced it would take on the Bunnings juggernaut in 2010 by moving into the $42 billion home improvement sector, the company has taken a lot of stick.
After Thursday’s long list of explanations for the ballooning losses to $157 million in its Masters home improvement business, it is likely to get a few more swings of the stick. The losses boiled down to misjudging the three essential parts of any retail business: sales forecasts, gross margins due to stocking the wrong product mix, and costs.
Given Masters chief Melinda Smith’s acknowledgement that five years ago, in preparation for Woolworths’ entry into this market, the company studied internationally renowned home improvement retailers, it didn’t inspire confidence to hear her comments: “We didn’t know a lot about this business when we set the budget for FY13.”
Her comments about the seasonal curve in relation to Masters joint-venture partner US-based Lowe’s also raised eyebrows. “We didn’t know a lot about the seasonal curve,” she said. “We’ve got a great joint-venture partner in America but when it’s Christmas time over there it’s also winter. Our Christmas time lines up with spring and Father’s Day, so it’s quite a different seasonal curve … we didn’t have the right stock in some instances.”
Against this backdrop, the company’s share price fell on a day when rival Wesfarmers, which owns the Bunnings hardware chain, and the broader market closed higher.
For more than a year investors have been trying to get information on how Woolworths’ home improvement business was doing, particularly after Merrill Lynch analyst David Errington started issuing reports questioning the strategy and potential drag on the overall business empire.
It wasn’t a pretty picture – and he won few friends at the company – but Woolworths kept silent and the speculation intensified that its Masters and Danks businesses were struggling and Lowe’s was ready to call it quits.
Woolworths finally updated the market on Thursday with revelations that the homeware business suffered losses of $139 million, 71 per cent higher than its budgeted loss of $81 million. This comprised a $157 million loss from its Masters business, compared with a forecast loss of $119 million, and a lower than expected profit from its Danks business of $18 million instead of an expected $38 million.
Earlier this week it emerged that Lowe’s had extended a put option to sell out of the partnership until October 2014. Woolworths’ chief financial officer, Tom Pocket, said Lowe’s had been very accommodating and was committed to the joint venture.
The challenge for Woolworths is convincing the market that the losses will stop. It said losses would not “exceed this year’s level” but that it would break even in 2016, which is in line with its original target. But given the size of the losses this year and next and the number and type of mistakes that were made, the market isn’t overflowing with confidence.
To put it into perspective, the $157 million loss doesn’t include allocated rental costs. The joint venture between Lowe’s and Woolworths owns most of the stores, so if the result was lease-adjusted it would blow the loss out to an estimated $200 million on revenue of $529 million. This is equivalent to losing more than 35¢ in the dollar, which is huge.
Woolworths has committed to opening 90 Masters stores by the end of 2016. To date it has 31.
The theory is the more stores, the greater the economies of scale and therefore the more profitable the business. But this isn’t necessarily the case. Several factors need to work to make a business profitable, including having stores in the right location. Indeed, some industry experts would argue that home improvement over the past two decades hasn’t been a scale game but a model game and some hardware chains have been able to make a profit by having the right product mix, product sourcing, labour and location.
In a report in April, Errington estimated it would lose $135 million on its hardware business in 2013, $195 million in 2014, $235 million in 2015 and $265 million in 2016.
It also renegotiated a deal with private equity group Anchorage, which bought Woolworths’ Dick Smith business in 2012 for $20 million, plus a promise to give Woolworths a proportion of any future profit growth.
Woolworths said it had “released” Anchorage from this obligation in exchange for $74 million, which consists of $50 million in June 2012 and $24 million in 2014.
Anchorage would no doubt be doing high fives on this new deal. When it bought the business last year it was generating more than $1.5 billion in revenue and a pre-tax profit of $24 million. The price included all assets and off-balance sheet leases.
At the time it was speculated that the inventory tallied up to $250 million.
The original release of this article first appeared on the website of Shanghai Night Net.