WOOLWORTHS' foray into the hardware market could wipe off as...

WOOLWORTHS' foray into the hardware market could wipe off as much as $2 per share in value for investors, according to Merrill Lynch retail analyst David Errington.

In a briefing note to clients, Mr Errington yesterday estimated Woolies could lose $623 million within five years of opening its first big-box hardware store, currently slated for late 2011.

Woolworths has teamed up with US hardware giant Lowe's to open a chain of warehouse-sized hardware outlets in competition with market leader Bunnings, which is owned by Wesfarmers. Mr Errington said one of Woolies' biggest challenges would be to secure well-located sites that could generate sufficient sales to be profitable.

Woolworths has set itself a target of securing 150 sites by the end of 2015, but Mr Errington noted that it has taken Bunnings 25 years to establish a portfolio of 160 stores.

"As we see it, Bunnings has reached probably every desirable demographic region in Australia," he said.

He also warned that planning regulations and local council approvals had been known to delay large retail developments by five years or more -- a factor that had also been mentioned by Wesfarmers boss Richard Goyder as a potential hurdle to Woolies' ambitions.

Merrill Lynch has forecast that the Woolies hardware stores will lose $61m in their first year of operation, rising to an annual loss of $190m after five years.

"Woolworths will be going head-to-head with Bunnings stores, probably in the same geographic location, with a sub-scale offer and with no competitive advantage," Mr Errington said.

In addition, Woolies' plans to have higher service levels than Bunnings would mean higher staff costs, while building a brand from scratch would require advertising expenditure.

Big-box retailers were also not able to reach the entire hardware market, with customers unlikely to buy commercial garden equipment at such outlets. Mr Errington said the real size of the market was closer to $12 billion than Woolies' estimate of $24bn.

A Woolworths spokeswoman said the company believed Mr Errington had "seriously underestimated the market opportunity" in hardware, while overstating the entry barriers to property development.

"We think the numbers that we based our strategy on are solid, realistic and achievable, otherwise we wouldn't be doing it," the spokeswoman said.

Mr Errington also raised the prospect of a conflict of interest between Woolies' proposed big-box division and the Danks hardware distribution business it is in the process of acquiring.

Woolies and Lowe's, which has a one-third stake in the joint venture, are in the process of acquiring Danks via an on-market takeover that values the target company at $87m.

Errington, who I have grown to dislike, puts a different spin on the transaction:

http://www.theaustralian.news.com.au/business/story/0,28124,26148144-643,00.html

Danks, which supplies about 2000 independent hardware stores including the Thrifty-Link and Home Timber and Hardware chains, will form the basis of the new venture's supply chain and distribution network.

However, Mr Errington said, Woolies' lack of initial scale meant it would be unable to source merchandise as cheaply as Wesfarmers, and even having access to Lowe's international buying strength would confer little benefit as more than 40 per cent of Australian hardware was domestically sourced or produced.

The holding of the two companies in Danks yesterday reached 80.09 per cent, closing in on the 90 per cent threshhold at which Woolies can make a compulsory acquisition of outstanding stock.