Wesfarmers is now a retailer, and CEO and boards should face up to that

TERRY MCCRANN
FEBRUARY 19, 2014
HERALD SUN
WHEN relatively new Wesfarmers CEO Richard Goyder decided to turn Melbourne retail entrepreneur Solomon Lew from a paper into a real-cash billionaire, with his monumental $20 billion takeover of the Coles retail group back in 2005, he almost certainly did not appreciate just how totally he was committing both his personal and the company’s future to the great Down Under war in the aisles and between the bowsers.
Fortunately, in 2008 he found Ian Macleod — probably better suited by both character and experience, than any other possible candidate — to wage that war for Wesfarmers/Coles; and wage it, most assertively and successfully as he has, almost from the moment he touched down, Down Under.
Although in a somewhat bizarre outcome, BOTH of the central parties to the war — Coles and Woolworths — have come out winners. It’s everyone else, aside of course from the shoppers, who have suffered the “collateral damage”.
The sheer size of the takeover meant Coles was always going to become the Wesfarmers main game, for years if not decades ahead. This was made even more so when the GFC hit.
Nearly a decade on, Coles is still the main game. More than half the group’s capital is employed in the Coles business; in the latest year it generated more than 42 per cent of group profit.
The differential between those two figures, though, demonstrates an equally critical point. Coles might be the main game in raw dollar terms, but the success of the overall Wesfarmers Group rides or falls equally, on the success of BOTH Coles and its long-held Bunnings home improvement chain, run even more successfully by John Gillam for just on a decade now.
Between them Coles and Bunnings contributed two thirds of group operational profit in the 12 months to end-December. What made Bunnings so important to the group was that its profit contribution came from much, much less capital employed.
Whereas Coles has $16.2 billion of capital employed in it, thanks of course to its top-of-the-market acquisition cost, Bunnings takes just $3.4 billion of group capital, invested over a long time, and now throws nearly a billion a year — $948 million in 2013, to be exact — back.
Yes, McLeod moves on from the war in the aisles and beside the bowsers, having got the Coles return on capital invested to the magic 10 per cent. But Bunnings returned 27.6 per cent on capital.
Just how crucial that is for the group can be shown by this calculation. The overall return of all the operational businesses was 12.4 per cent. Take Bunnings out and it falls to 10.5 per cent. The group return would be effectively set at the Coles return.
This shows how critical it is for Gillam to see off the challenge from Woolworths’ Masters thrust: in his case, playing the defending role, like Woolies in the supermarket aisles.
So far, not just so good, but better than that, with Bunnings lifting revenue by 10.5 per cent in the half, and suffering very little margin leakage as the operational profit was up 9.5 per cent.
THERE was a further, fundamental, structural message in the Wesfarmers numbers, and beneath that two specific operational messages or challenges.
Wesfarmers is now a retailer, and CEO and board should face up to that. Add on the contributions from its other retail brands, and the total retail contribution to group operational profit goes above 80 per cent.
More than that, the other bits and pieces — insurance, chemicals and fertiliser and so on — might produce reasonable profits, but they no longer make structural or operational sense.
Yes, they might provide linkages to some parts of the customer base, throwing back to the company’s farmer co-operative roots, but they are increasingly just that — bits and pieces. Their returns can be erratic; and, bluntly, they just don’t matter to the group’s fortunes other than potentially negatively.
At core, if you can’t really justify investing more growth-focused capital in them, you really can’t justify continued ownership.
It really is time that Goyder and the board faced up to the reality — that the company’s future rides or falls in the retail space.
Now he has to some extent, with the sale of part of the insurance operation; and he’d sell the rest if a bidder surfaced.
Of the rest, resources in particular — essentially energy coal — sticks out like a sore thumb. A few years back it looked like a nice little earner in the group portfolio. Now it’s at the dog end of the wavering resources boom and sub-sub-scale to boot.
Wesfarmers should have sold it when all coal was running hot. Just like the National Australia Bank — ironically, chaired by Goyder’s predecessor, Michael Chaney — should have sold its dead-end British banks when banking was hot before the GFC.
The two more specific messages is that in this “retail Wesfarmers”, Target and Kmart are now also big enough to matter — Target big enough to be a serious negative, Kmart big enough to make a significant contribution to the group result.
Kmart was the third biggest profit contribution over the 12 months with $358 million; Target contributed a miserable $58 million — despite having more than twice the capital invested in it than Kmart — $3 billion as against $1.3 billion.
Put it another way: if Target had generated the same return on capital as Kmart, it would have contributed almost as much as Bunnings — around $800 million. And it would have lifted the group return on capital from 12.4 to 14.8 per cent.
Equally, if Kmart had performed at Target’s level, it would have dragged down the group return to 11.3 per cent. And, very interestingly, dragged the group return, measured to exclude Bunnings, down to just 9.2 per cent — BELOW the Coles return.
Guy Russo, who’s been running Kmart since 2008, seems to have finally found the way to make it work in the challenging bricks-and-mortar space; it is also big enough to matter and matter positively in the group scheme of things.
Target is a very different matter. It has to be a case of swim or sink for Stuart Machin who was given the job only last year. And probably rapidly.
Goyder should understand the time for corporate action might soon be now or never. The best chance of realising a Target sale would be into the flux created by any move to merge Myer and David Jones.
If Myer’s otherwise-departing CEO Bernie Brookes sincerely wants DJs and also wants to maintain a brand differential, bringing — returning — Target in as the third tier makes great sense. ACCC permitting.