Wesfarmers has yet to fully recover the value stripped from it by last week’s announcement from retail rival Woolworths that it was entering the hardware sector now dominated by Wesfarmers’ Bunnings. The market’s attitude is curious, given that any material impact from that decision is years into the future.
Wesfarmers initially, and instantly, lost about $1.5 billion of market capitalisation after Woolworths announced that it was bidding for hardware distributor, Danks Holdings, and entering a 70:30 joint venture with US group Lowe’s to roll out a chain of ‘big box’ format hardware stores.
The announcement coincided with Wesfarmers’ shares trading ex-dividend but, even taking that into account Wesfarmers is still valued about $600 million less today than it was a week ago.
Given the time – the years – it will take for Woolworths’ offering to have any material impact on Bunnings, the hardware discount attached to the Wesfarmers’ share price implies a very substantial eventual transfer of value from the incumbent to the aspirant; one measured in billions of tomorrow’s dollars rather than the $600 million today.
Woolworths hopes to open 150 stores over the next five years, with the first scheduled to open in late 2011. So far Woolworths has secured 12 sites and is negotiating another 15. Bunnings itself plans to open another 30 to 40 warehouse stores in the next three years, with 10 already under construction and 20 in the planning and development phase.
It generally takes about two years to get through the development approval process, while it also takes another two or three years for large store formats to build sales to optimum levels. In other words, even if Woolworths can acquire 30-plus sites a year to meet its initial target for the network, many of those stores will still be ramping up their sales as we close in on 2020.
The acquisition of sites appears to be where analysts believe the greatest risk lies in the Woolworths strategy – that’s a lot of sites to acquire in a relatively short time, particularly when one considers that it has taken Bunnings a quarter of a century and a couple of big acquisitions to create its network.
Bunnings has been opening smaller stores in more densely urbanised locations, suggesting that the availability of large-format sites in the right catchment areas is starting to dwindle. The analysts appear concerned that, as the late entrant, Woolworths will end up with a network of less-than-optimal sites at a cost of $20 million to $30 million per site.
Regardless of how well Woolworths executes its strategy and whether or not it can create a business that is both competitive with Bunnings and delivers Woolworths-type returns – Woolworths is a first-rate retailer and competitor – the time-lines don’t suggest an immediate or early impact of particular consequence to the Wesfarmers group.
That is very significant because at this moment Wesfarmers would be vulnerable to an assault on Bunnings, a core profit generator for the group. Those earnings are vital to Wesfarmers as it invests heavily in its Coles food and liquor business and attempts to revive the Kmart brand. This year the Wesfarmers group expects to invest $1.8 billion of new capital in its portfolio of businesses.
The Coles turnaround, as Richard Goyder continually says, is a five-year program that started in late 2007. That means it should finish around the second half of 2012, with the peak of the capital expenditure programs occurring some time well before then.
In other words, by the time Woolworths has assembled its network of big-box stores and ramped them up the attempt to rehabilitate the Coles brands will, regardless of how successful it has been, be behind Wesfarmers and the group should be in a far stronger and less vulnerable position to defend any of its franchises.
Indeed, at that point, having outlaid a lot of capital to take on arguably the world’s most profitable hardware retailer and a very strong retail brand after giving it a 25-year head start, it may be Woolworths that comes under pressure from the market given that the big investments in the attempt to take on Bunnings will lead, by several years at least, the build-up in sales and returns. The market may have been a bit premature and heavy-handed with its markdowns
WES Price at posting:
$25.38 Sentiment: Hold Disclosure: Held
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