Axing Masters is just the start to fixing Woolworths

Co-founder of the Switzer Report
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This article was originally published on Switzer Daily January 21, 2016.

At least Woolworths chairman Gordon Cairns has made an early call to exit the home improvement business. However, Masters is only one of four problems facing the Woolworths Board, and while axing Masters is a step down the right path, Woolworths is not out of its misery yet.

The sharemarket’s initial reaction to the news saw Woolworths shares jump by over 8%, however wiser heads soon recognized that closing Masters is going to be hard work and while Woolworths will ultimately stem the bleeding, the real winner is Wesfarmers. By close of business yesterday, Woolworths shares had put on just 4.1% this week, compared to a rise of 1.9% for Wesfarmers.

Woolies problems

The first problem for the Woolworth’s board is to appoint a new CEO. Grant O’Brien stepped down from the position back in June last year – and 7 months later, Woolworths is still to fill the position. While a new CEO should be a long term positive for the company, newly appointed CEOs tend to make changes to the management team, which can be disruptive to a company trying to get back on its feet.

Problem number two is Big W. With EBIT of just $4.5m in the second half of FY15, deteriorating sales results, and a branding crisis, this chain is bleeding cash and management time. In the most recent quarter ending October 2015, comparable store sales for BigW fell by 8.1% compared to the corresponding quarter in 2014. Over at Wesfarmers, Kmart increased comparable store sales by 8.6%, while Target increased comparable store sales by 3.2%.

And then the real problem is the supermarket business. Competition from Aldi, IGA, Costco, potentially Lidl and of course Coles is undermining Woolworth’s market share and threatening margin. Woolworths is being trounced in the sales war by Coles – in the most recent quarter, comparable store sales for Australian food and liquor declined by 1.0% compared to the corresponding quarter in 2014. Over at Coles, comparable store sales for food and liquor rose by 3.6%.

There are no signs yet that this trend has changed, with anecdotal reports suggesting that Woolworths had a pretty tough Christmas period. We will find out in a couple of weeks the truth if this is the truth or not. The point, however, is notwithstanding a resolution to the Masters debacle, there are a myriad of challenges still facing the Woolworths’ board.

Closing Masters will be hard work

While making the call is arguably the hardest part of the process, the task to close the Masters business will require a lot of hard work and management effort. Firstly, Woolworths and their partner, Lowes, are yet to agree on the price for Woolworths to acquire 100% ownership. Although there is a process laid down, it will potentially require 3 independent valuations to determine the value of the business.

Once acquired, then there is the problem of selling it. The separately branded Home Timber and Hardware business may readily find a buyer, but the Masters business will struggle. While Bunnings is the obvious buyer, competition concerns may render it unable to bid – at least for many of the sites which generally have very long term leases. More than likely, Woolworths will end up closing many of these huge stores, particularly those built opposite or adjacent to a Bunnings Warehouse.

Closing a business is never easy, and while Woolworths will provide an update to the market about the cost when it reports its first half results in February, the betting is that closure will take longer, and be more expensive, than the market is expecting.

The brokers are still downbeat

Woolworths remains one of the most heavily shorted stocks on the Australian Stock Exchange. According to the latest ASIC figures (which are based on trade date positions reported from Thursday 14 January), 9.62% of Woolworths ordinary shares – a staggering 122 million shares worth around $2.8bn – are short sold. So far, no sign of the professionals changing their minds.

And the brokers remain downbeat. Despite the expected positive commentary on the Masters exit and a small upgrade to FY17 earnings, the brokers are still negative. According to FN Arena, of the 8 major brokers, 5 have sell recommendations, with 3 neutral or hold ratings. No buy recommendation. The consensus target price for Woolworths is $23.00.

In contrast, Wesfarmers has 2 buy recommendations, 5 neutral or hold ratings, and one sell recommendation. The consensus target price is $40.72.

With Woolworths, one swallow does not a summer make.

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