Woolworths’ loss-making hardware start-up, Masters, admitted a failure to understand the hardware business

Woolworths ‘failed to understand’ hardware

July 18, 2013 – 4:59PM

Eli Greenblat

The director of Woolworths’ loss-making hardware start-up, Masters, has defended the overly optimistic sales and earnings forecasts set down for its new business, but admitted a failure to understand the hardware business. Addressing analysts in the wake of Woolworths being forced to blow out its projected losses for Masters in its first five years, CEO Melinda Smith said the company failed to grasp the seasonality of hardware and acknowledged she didn’t know a lot about the structure of the business when it began. “We didn’t know a lot about this business when we set the budget for financial 2013,” she said. “We didn’t know a lot about the seasonal curves,” she added. “We didn’t have the right stock in some instances.”Merrill Lynch analyst David Errington questioned why the market should trust Woolworths’ revised forecasts for its hardware division given it got the basics of its original forecasts so wrong.

“Why are you so optimistic that in financial 2016 you will break even when its been proven that you have been too optimistic … and particularly given that you were overly optimistic in the three most critical parts of retail – sales, gross margins and costs,” Mr Errington said.

“Why should we trust your optimism in this business being break-even in 2016 when you have been proven to be massively overly optimistic.”

Scale of losses

Woolworths said it had forecast Masters to record an EBIT for 2012-13 of a loss of $119 million but that should now blow out to a pre-tax loss of $157 million.

Releasing a statement to the Australian Securities Exchange, Woolworths said the higher losses were due to overly optimistic sales budgets, relatively higher wage costs for new store openings and lower margins due to the sales mix.

Woolworths also announced revised earnings guidance, saying it now expected net profit after tax from continuing operations, excluding non-recurring items, to grow in the range of 5 per cent to 6 per cent, against previous guidance of growth of 4 per cent to 6 per cent.

Woolworths is still forecasting that Masters will break even during financial 2016, assuming more moderate growth in sales per store and improvements in gross margins.

Woolworths expected the losses for financial 2014 not to exceed this year’s levels.

Ms Smith said Woolworths didn’t expect its whitegoods offering to perform strongly as it was a lower-margin category for the retailer.

‘Helpful’

But she said its joint venture partner in the US, hardware giant Lowe’s, was helpful as it developed the Masters chain and rolled it out but Woolworths faced challenges unique to the Australian market.

“We have a great joint venture partner in America but when its Christmas time over there its also winter, our Christmas time lines up with Spring and Fathers Day so its quite a different seasonal curve.”

Its Danks wholesale hardware business would only record EBIT for financial 2013 of $18 million against an original forecast of $38 million. That meant Woolworths hardware division would post an EBIT loss of $139 million in 2012-13, against a forecast of a loss of only $81 million.

The company said Danks earnings were lower than forecast due to similar problems experiences at its Masters chain, higher levels of competition and subdued trading in the building sector.

Analysts had been questioning lately the true cost of the Masters roll out and the losses it was accumulating for two-thirds owner Woolworths.

Some analysts believe Woolworths could rack up losses of up to $265 million by 2016 as it looks to establish 150 Masters sites around the country.

Roll-out

In its hardware update this morning, Woolworths said there were currently 120 active sites on its books for Masters and at the end of 2012-13, 31 stores were open. But due to the timing of approvals and construction the number of store openings in the first quarter of 2013-14 would be lower than the recent run rate.

Woolworths also moved this morning to quash any suggestion its one-third partner in Masters, US hardware giant Lowes, was seeking to dump its stake in the Australian business and walk away from the partnership.

Woolworths said Lowe’s had decided to extend the first exercise date of their put option (which would force Woolworths to buy them out) for another 12 months to October 2014.

As part of the Masters hardware update, Woolworths also said this morning it had agreed to release private equity firm Anchorage Capital Partners from its obligation to deliver Woolworths any upside resulting from the future sale of electronics group Dick Smith.

Woolworths sold Dick Smith to Anchorage last year and had agreed to some upside in the future if the business was later sold.

Woolworths said this morning in return for the new deal it would receive payments of $74 million to be booked as income in 2012-13.

As a result of these additional proceeds the loss to Woolworths from the sale of Dick Smith of $65.7 million shown in its half year 2013 results will become a profit of $7.9 million in financial 2013.

Woolworths said when it announced its move into the $40 billion Australian hardware sector in 2010 it said it would take five years from the first store opening for the joint venture to become a profitable division in its own right.

“We are confident that our home improvement business remains on track to be a business that will be built in the first five years and deliver returns in the following years.”

The company said it had learnt from its early mistakes.

”As a greenfield business we expected many challenges and along with our joint venture partner Lowe’s we have learnt a lot over the last two years.”

Woolworths Sees A$157 Million Loss for Lowe’s Venture Masters

Woolworths Ltd. (WOW), Australia’s largest retailer, expects to lose A$157 million ($145 million) in the year ended June for its Masters home-improvement joint venture with Lowe’s Cos. The shares fell.

Sales from the 31 Masters stores came to A$529 million, Sydney-based Woolworths said in a regulatory statement today. The hardware division as a whole, which includes the Danks trade merchant business, lost A$139 million before interest and tax compared to a forecast of an A$81 million loss.

Weak consumer confidence and high start-up costs had weighed on performance in Masters, which along with Danks is 33 percent owned by Lowe’s according to Woolworths’ last annual report. Sales budgets were too optimistic, wage costs were too high in new stores, and the profit margin between wholesale and retail prices was too low, according to the company.

“The company looks to be facing a period of lower growth in the foreseeable future, and the earnings drag from its entry into hardware is inopportune timing,” David Errington, an analyst at Bank of America Corp.’s Merrill Lynch division, wrote in a note to clients April 26. “The drag from hardware looks likely to us to soon become substantial.” The division would lose A$135 million before interest and tax this year, Errington forecast at the time.

Woolworths shares fell 1.5 percent to A$33.18 at 10:20 a.m. in Sydney, compared to a 0.4 percent rise in the benchmark S&P/ASX 200 index.

Woolworths also revised its forecast for net income in today’s release, to a tighter range of 5 percent to 6 percent growth from 4 percent to 6 percent

To contact the reporter on this story: David Fickling in Sydney at dfickling@bloomberg.net

Hardware losses stacking up for Woolies

July 18, 2013 – 3:33PM

Stephen JohnsonAAP

Woolworths is bracing for its home improvement division to lose $139 million as the building sector struggles and wage costs blow out.

The retail giant was hoping that Masters Home Improvement would challenge the dominance of Bunnings when its first stores opened in 2011.

But two years on, Woolworths’ hardware division is bleeding, with executives admitting they were too optimistic with their sales forecasts.

The flagship Masters group suffered a $157 million loss in fiscal 2013, in earnings before interest and taxes (EBIT), which was deeper than a forecast $119 million loss.

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It comes as Woolworths’ overall home improvement division suffers a $139 million EBIT loss during the same period, which is steeper than an estimated $81 million loss.

Masters director Melinda Smith said the Woolworths joint venture with US hardware retailer Lowes had been too optimistic with sales forecasts, amid high wage costs for new stores and a lack of customers.

“We just put quite aggressive-stretch targets in for every store in FY13 across the board and, in hindsight, that just wasn’t a reasonable thing to expect,” she told analysts on Thursday.

“We didn’t know a lot about this business when we set the budget for FY13.”

Masters is expected to make another loss in 2014, before breaking even in fiscal 2016, as sales grow moderately at individual stores.

IG market strategist Evan Lucas said Masters was struggling to compete against established hardware store chain Bunnings, as consumers cut back on discretionary spending.

“The Masters brand has not been as strong as they were hoping,” he said.

“The amount of money they have injected, for the return to be pushed out to FY16, is a concern and would probably suggest they are losing out on market share as well.”

Meanwhile, hardware and garden distributor Danks posted an $18 million EBIT for fiscal 2013, compared with a forecast of $38 million.

“As head of the business, I’m clearly disappointed,” Mark Burrowes, the general manager of Woolworths’s Home Timber and Hardware Group, said.

“The market conditions out there are very challenging.”

Woolworths blamed Danks’ disappointing earnings on “higher levels of competition in a subdued trade and building sector”.

The retail giant is forecasting that Woolworths’ overall full-year net profits will rise by between five and six per cent in fiscal 2013, compared to earlier estimates of four to six per cent.

But this is before significant items totalling $105 million are factored in, which includes the costs of a US bond redemption, the outsourcing of its transport fleet in Victoria to Linfox and the establishment of the SCA Property Group.

In another development, Woolworths won’t require Australian private equity firm Anchorage Capital Partners to pay benefits arising from the future sale of the Dick Smith electronic stores.

Woolworths will receive now $74 million, bringing proceeds from the sale to $94 million.

Shares had fallen by 43 cents, or 1.28 per cent, to $33.26 at 1439 AEST, on a day when the overall market was in firmer territory.