Thinking outside the square
Saligari has suggested Wesfarmers could cash in on Kmart’s current strong performance and equity value by selling the chain and focus on fixing the struggling Target chain.
Target has become a basket case for Wesfarmers, shedding 18 per cent of sales on a same store basis for the half year to 31 December 2016 and seeing net earnings fall by 78 per cent to $16 million for the half.
Wesfarmers restructured its discount department store operations last year under Kmart managing director, Guy Russo, and some of the profit loss can be attributed to turnaround costs.
It took Russo more than five years to get Kmart firing on all cylinders so a turnaround for Target in less than a year was never a prospect. However, the question is how long will rejuvenation of the chain take and is it possible with new international retailers entering the market?
There are other question marks about a Target turnaround of course, including crucially, whether or not a resurgence for that chain have an adverse impact on Kmart.
Saligari’s view that Wesfarmers should sell Kmart while it’s hot is, in part, based on the premise that a turnaround for Target will damage Kmart’s performance.
Drop it like it’s hot
No doubt, Saligari’s thinking on the discount department store dilemma for Wesfarmers will have been encouraged by the willingness of the conglomerate to divest its successful Officeworks chain.
Wesfarmers has appointed advisers to assess a potential spinoff on the Australian Stock Exchange of Officeworks, which has around 160 stores and annual sales approaching $2 billion.
Launched in 1994 by the Coles Group that was subsequently acquired by Wesfarmers, Officeworks is now a mature business and, although well managed, faces lower growth prospects in the future.
As Saligari argues in respect of Kmart, Officeworks is arguably at the top of its value with solid sales and earnings growth.
Officeworks has been structurally bundled in with Bunnings Warehouse for many years, an unusual fit but now much more awkward as Wesfarmers hardware chain pursues opportunities in the UK.
The chain might well have been transferred to the discount department store division if Target’s position were not so dire.
Rediscovering Target’s mojo
While Saligari’s notion of selling off the strong performer, potentially at peak value, to nurture and increase the value of the struggler has some logic, the proposition ignores the fact that the discount department store sector is over shopped.
There is also the fact that it would seem to make Target’s turnaround that much more difficult if Wesfarmers were to follow Saligari’s thinking and establish Kmart as a competitor under new owners, rather than a stablemate that can ease the task with shared backroom support services and buying clout.
Russo faces a big challenge to reinvigorate the 300-store Target chain which lost its mojo, interestingly, around the time it expanded into direct sourcing from overseas suppliers.
Although Target attempted to use a number of signature designer ranges, including Stella McCartney, to underpin its fashion credentials, the chain lost credibility with customers.
Russo has cut $300 million from $900 million inventory and is keen to cut deeper and is attempting to refocus Target to the everyday low prices proposition that Kmart used as the key plank of its turnaround.
Taking costs out of the business and cutting back on suppliers were already strategies Target management was pursuing under a transformation plan implemented before Russo took control of the flagging chain.
These measures will provide some profit gains in the short term but Target will continue to struggle, unless it can identify and execute a repositioning that will allow it to thrive alongside Kmart, Big W, Harris Scarfe, Best & Less, Myer and even Costco.
That is not to mention the international retailers expanding in Australia along with the internet vendors, including Amazon, which is now focused on building a physical presence in Australia.
As Russo claims, Target has an advantage over many competitors in scale but big can be unwieldy and, in fashion, customers are increasingly looking for something different, a key factor in the appeal of the fast fashion concept.
If the existing range of competitors in the market was daunting enough for Target, there are more international retailers sizing up the market, including the Massachusetts-based TJ Maxx clothing, footwear, bedding and homewares chain.
TJ Maxx has more than 1,000 stores and bought 35 Trade Secret stores from the Gazal Corporation in 2015 for $80 million.
Those stores are now the platform for the launch of the TJ Maxx brand and retail format in Australia.
Russo is correct in pointing to the scale of Target, but there is little comfort in it, as no one competitor needs to get that big to become a serious threat to the survival of the struggling Wesfarmers chain.
All the smaller store networks of the international retailers can chip away at Target’s heels and make it that much more difficult to convince customers of its fashionability and leave it more vulnerable to its existing homegrown competitors such as Harris Scarfe, Big W and Kmart.
Bunnings’ venture into the UK
Peter Davis was one of the original management team in West Australia that developed the Bunnings Warehouse big box format and has played a significant role in the chain’s extraordinary success.
Davis is now in the UK overseeing the revamp of the Homebase chain, which Wesfarmers bought from Home Retail Group in January 2016 for $705 million.
Wesfarmers has budgeted for an investment of $1 billion over the next five years for the reformatting and rebadging of existing Homebase stores and the rollout of new outlets.
Bunnings’ UK hardware business booked a $48 million loss for the half year ended 31 December 2016 on sales of $1.03 billion.
The loss was expected, as Davis and the new management team began restructuring the business, which is the second largest hardware retailer in the UK with 265 stores.
While Homebase has scale, its trading performance had waned under its previous ownership with low productivity in terms of sales per square metre.
Davis said customer transactions have already increased by 9.1 per cent after some initial changes to the stores, including range restructuring.
Financial analysts in Australia retain their scepticism about the Homebase acquisition, but Wesfarmers claims the chain will provide an 18 per cent return on capital within five years.
Davis expects a better second half performance for the Homebase chain, as the figures will include northern hemisphere summer trading, while clearance activity is largely complete and concessions within stores are being closed.
Davis has told analysts Bunnings has introduced higher stock weights and wider assortments to improve floorspace productivity and has moved to an ‘Always Low Prices’ proposition that has started to gain traction with customers.
Four Homebase stores will be converted to the Bunnings Warehouse format and rebadged in the current financial year, the first one having been unveiled at St Albans in Hertfordshire in February.
The 67,000 sqm store carries more than 30,000 products, a 40 per cent increase in stock units compared to the average Homebase store.
Meanwhile Veronique Laury, the CEO of the UK’s largest hardware retailer, B&O, was critical of the lack of service in the new Bunnings Warehouse store. B&O is itself in the process of a restructure as a result of disappointing growth. B&O has closed stores and is revamping its range and, while it does not concede that the Bunnings Warehouse model is a threat, the new competitor is a factor in the shake up of the Kingfisher Goup’s hardware chain.
Davis expects to have up to 10 stores trading in the Bunnings Warehouse format by the end of the calendar year but points out that Wesfarmers will closely monitor trading results and adjust its plans for the UK division accordingly.
Unlike the Target dilemma of finding a proposition that will deliver sustainable long term growth, Bunnings Warehouse has a proven formula that, if necessary, can be tweaked for the UK market.
Davis also has the prospect of new store growth throughout the UK, as Homebase has around 75 per cent of its stores within greater London and surrounding counties with high population densities.
The major question mark Wesfarmers has for its UK hardware business is the impact on consumer confidence and the economy of Brexit over the next few years.
However, Davis and Wesfarmers are confident of the potential to improve same store sales through better inventory plans while it works on the rollout of its new store formats.