Wesfarmers smart to offload Coles side businesses

Wesfarmers’ decision to divest Coles food, liquor and convenience business surprised some retail analysts but it was arguably prudent to exit the increasingly competitive category.

The value of the Coles supermarkets business had almost certainly peaked, notwithstanding the demerger into a new entity listed on the Australian Securities Exchange. The listing unfortunately coincided with a period when investors were bearish on retail stocks.

Coles had lost some of the ground it had made up on the market leader Woolworths in recent years as it headed towards the demerger but added a little pep to the deal with the success of its Little Shop collectible promotion.

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Buffeting volatile headwinds

While the supermarkets were still a formidable business generating strong cash flow and consistent earnings, the Coles liquor business has been something of an underperformer, and the convenience and fuel business was buffeted by volatile market conditions. However, it was the lack of growth potential of the three businesses that really prompted Wesfarmers to divest. 

If the company could find the right formula for its liquor business of around 900 stores, there was certainly upside and growth potential there; but the 700-site convenience and fuel business channel is more likely to contract than to expand.

The supermarkets business is also facing lower growth, with a mature store network of around 800 stores and increased competition in the category as Kaufland launches in Australia and Costco and Aldi continue to expand.

In announcing the demerger, Wesfarmers MD Rob Scott noted that divesting the Coles food liquor and convenience business would allow the company to have a greater focus on growth opportunities. He noted the Coles business accounted for some 60 per cent of capital investment and returned 34 per cent of group divisional earnings; a Wesfarmers review of its business portfolio would have indicated that supermarkets would have a high ongoing appetite for capital funding if they were to remain competitive in the category.

While Coles Online offered some potential to expand market share and sales, profitability was elusive, and scaling up the operation to boost sales and the bottom line was also going to require significant additional capital funding.

Prior to the decision to divest the Coles businesses, Wesfarmers had considered the sale of Officeworks but opted not to proceed with an ASX listing for the business because of market volatility and lower-than-expected price valuations. Wesfarmers now seems to be very comfortable with the decision to retain Officeworks, which posted an 8 per cent increase in sales for the 2019 financial year.

Officeworks goes big

While the return on capital invested – 17 per cent – is below the Kmart and Target group’s 29 per cent and Bunnings’ remarkable 50.5 per cent, Officeworks has considerable growth potential in a fragmented market. In the Melbourne bayside suburb of Mentone, it has unveiled a new 6500sqm store that is around four times average size and carries some 35,000 products as well as expanded services. It is also a fulfilment centre for online customers.

There is a view that the Bunnings powerhouse may see its growth rate taper off given the maturity of its store network; however, Wesfarmers believes it still has opportunities for growth as it starts to put a greater focus on online sales generation.

Focusing on growth

Bunnings is the dominant player in the fragmented hardware market but has the broadest retail offer in terms of merchandise ranges for consumer and trade customers and probably has elbow room for further acquisitions after buying South Australia’s Adelaide Tools, which has five stores in Adelaide.

While Bunnings and Officeworks would seem to meet Wesfarmers’ growth focus, the Kmart Group may well be under future scrutiny, notwithstanding its solid earnings and return on capital.

The discount department store category has too many stores and is highly competitive with the new market entrant Kaufland set to add to the floorspace along with the expanding Costco and TK Maxx.

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