Masters’ moment of truth

mastersThe fate of the Masters Home Improvement chain is expected to be revealed within a fortnight as both joint venture partners report on their operations to shareholders.

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The North Carolina-based Lowes is scheduled to release its third quarter financial results on November 18, while Woolworths faces the prospect of a challenging annual shareholders meeting the following week, on November 26.

The joint venture partners are likely to have already decided their position on Masters Home Improvement, which has racked up massive losses since it launched in 2011. But an announcement is most probable when Lowes unveils its trading results.

Lowes has an exit clause in the joint venture agreement struck with Woolworths for the development of the Masters Home Improvement chain and the trigger date for a 12-month notice of termination was October 20.

If Lowes plans to quit the joint venture, Woolworths faces the prospect of injecting around $800 million to $1 billion more into the troubled chain to buy out the US retailer’s shareholding, an outlay that would generate an outcry from hostile shareholders.

A decision is market sensitive, with most analysts believing Woolworths’ flagging share price would be likely to improve if the company bites the bullet on the hardware venture.

Investors and analysts are also keen to see the revamped Woolworths board, headed by new chairman, Gordon Cairns, part ways with the Big W discount department store chain to concentrate on its core food and liquor business.

Cairns has previously said the future of the hardware business will be determined by the numbers, its sales and projected earnings, and return on investment calculations.

None of the financial metrics look promising, with the first quarter financials indicating that stores are still struggling to generate annual average sales of $20 million, well short of initial forecast revenues per store of $30 million.

While Woolworths boasted a 23.5 per cent lift in first quarter sales to $294 million for the 62 Masters stores, analysts remained unimpressed, with those revenues translating to average of less than $5 million a store and clearly still shedding buckets of red ink in terms of profitability.

Woolworths reported on October 4 that new stores opened in the 2015 financial year in a re-vamped format were tracking 30 per cent above stores in the original configuration. But the retailer conceded that it was too early to properly assess new store results.

There was no boast about a significant lift in like for like sales to reflect traction in the store re-fits, new products and overhaul of the merchandise range.

Masters Home Improvement is doing better than it was 12 months ago, but is still floundering and burning money. It is no closer to profitability today than it was when it launched in 2011.

Analysts believe Woolworths will abandon the hardware venture if Lowes has, or is about to, trigger the buyout clause. But it is more likely that Woolworths has been first to blink and accept market pressure to close the stores and sell of the assets locked up in the venture.

The major assets of the business are in property, but the Home Timber & Hardware division, which has annual sales of around $1 billion, could also tempt Metcash, which owns Mitre 10.

Alternatively, a private equity player could well be interested in buying and merging both the Mitre 10 and Home Timber & Hardware with both Woolworths and Metcash willing sellers, given they are both struggling to defend sales, earnings and market share in their core supermarkets businesses.

Woolworths’ losing Masters battle
Protected by the original joint venture agreement, Lowes may be able to exit Masters Home Improvement at little or no loss. But Woolworths could face a writedown on capital invested of between $2.2 billion and $3.3 billion before the liquidation of assets.

Citigroup has estimated a net loss for Woolworths on an exit from the hardware venture would be between $300 million and $900 million, but most pundits believe the price would be somewhat higher.

The difference in the two figures reflects whether or not Lowes will be entitled to the buyback of its one-third shareholding, which has to date consumed more than $1 billion of the US retailer’s funds.

Speculation about the closure of the Masters Home Improvement chain has risen in recent weeks as evidence of its continued poor financial performance is assessed by financial analysts and institutional investors.

That speculation was fuelled in the past week by reports that the British retail executive recruited to implement a turnaround strategy for the business is leaving.

Matt Tyson was appointed in January 2014 as MD for Masters Home Improvement, but he has been unable to stem mounting losses because of legacy issues in the venture.

Despite slowing down new store openings, retrofitting existing stores, revamping product ranges and refocusing marketing activity, losses are continuing to balloon.

Despite missing all of its projections on sales and profitability as well as store development targets, Woolworths would not be under intense pressure from financial markets if its powerhouse food and liquor business was not losing sales momentum and market share.

Woolworths remains Australia’s largest retailer and food and liquor business, but stronger growth from archrival, Coles, has troubled analysts and shareholders.

Woolworths is keen to identify $500 million in cost savings to re-invest in lower pricing and has revamped its loyalty programs, as well as lifted spending on store upgrades in a bid to regain sales momentum and to stem the loss of customers to Aldi and Costco.

With its shares currently priced at less than half their value in 2014, a downcast Woolworths has in the past week warned shareholders that first half earnings are expected to be down by between 28 per cent, and 35 per cent in the current half of the financial year.

In what is effectively the third profit downgrade by the retailer this year, outgoing CEO Grant O’Brien said net earnings for the half are likely to fall below the $1 billion mark as the company accepts the “short term consequences” of focusing on the best long-term decisions.

Big W buyout?
While it is not as crucial to Woolworths, analysts and institutional investors are also keen to see the retailer divest its Big W discount department store, which is suffering sharply declining sales and profits.

In the first quarter of the 2016 financial year, Big W’s sales fell by 7.9 per cent, from $1.05 billion in the comparable period last year to $974 million.

In the full 2015 financial year, Big W shed $240 million in sales with same store sales down 7.2 per cent.

In part, the dramatic fall in sales can be attributed to problems with the ‘project galaxy’ stock management system that has been roundly criticised by suppliers.

But competition in the DDS category and leadership issues that has seen two managing directors, Julie Coates and Alistair McGeorge, gone in just over a year, are also factors in the declining fortunes of the chain.

Blackstone, the New York-based private equity firm, is understood to have been evaluating Big W as a buyout opportunity or a joint venture.

Several other private equity firms, including Kohlberg Kravis Roberts, have also been linked with Big W’s future, in what is understood to be a Woolworths driven process

Big W is likely to command a price tag of around $2 billion, down from the $3 billion it might have realised when sales and earnings were stronger in 2013.

Woolworths is sensitive on the pricing issue after gifting the Dick Smith business to private equity firm, Anchorage Capital Partners, on an extraordinarily generous deal.

As with the Dick Smith business, notwithstanding its lacklustre financial results, Big W is still a major revenue generator, is profitable, and, unlike Masters Home Improvement, has heritage in the Woolworths business.

As a result, there is speculation that Woolworths is more likely to be interested in recruiting a joint venture partner than an outright sale, a move that would inject more funds and management expertise into the business.

Such a move would be unusual in an existing business, but it would fend off the baying analysts and institutional investors and allow Woolworths to divert funds to the reinvigoration of its supermarkets.

A joint venture on Big W could also allow for that business to be restructured and repositioned, with Woolworths able to buy out the private equity partner in the future.

A masterful twist?
In another twist in the Masters Home Improvement saga, it is also within the realms of possibility that Lowes could buy out part, or all, of Woolworths two-thirds share in the venture.

Lowes is not under the same pressure from shareholders as Woolworths, has deeper pockets, and may well take the view that the business could yet have a profitable future in the fragmented hardware and home improvement category.

What is certain is the fact that Cairns, Woolworths’ new chairman, is not averse to making big decisions. He had not occupied the chair for long at David Jones before leading board support for the Woolworths South Africa takeover that scuttled a merger proposed by Myer.

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