Wesfarmers-Bunnings Strategy Day
The plan for 2017/18
Michael Schneider, CEO Bunnings
Michael Schneider, CEO Bunnings
 
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Is Bunnings planning for a market slowdown?
Wesfarmers
Each annual Wesfarmers' Strategy Day, from the perspective of reporting on Bunnings, tends to fall into one of three categories. Type A is when Australia's largest home improvement retailer is making an investment in something controversial - such as when it radically expanded its store network in response to the challenge from Masters Home Improvement - and needs to both announce this and defend it under questioning from investment analysts.

Type B is when Bunnings is doing something a little controversial, but not very obvious, so the company can get it past the analysts by either not emphasising it, or by making it seem as though something else is being referenced. Type C is when some other event has occurred outside of Wesfarmers that has captured the analysts' attention, and coloured their attitudes and questions.

This year's Strategy Day, held on 7 June 2017, was mostly type C, with a dash of type B added. The exterior event that captured the attention of the analysts was the imminent arrival of the world's largest online retailer, Amazon, to the Australian market. Analysts came close to suggesting that some of Wesfarmers' divisions, in particular its still-failing mid-range department store Target, were unlikely to survive the arrival of Amazon in the Australian retail market.

Bunnings did not come in for that level of questioning, but analysts did push to understand what the retailer's online strategy would be over the next two to three years.

All this is to say that it's always a good idea to keep in mind that "Strategy Day" goes both ways when it comes to Wesfarmers, and particularly Bunnings. Analysts do get an opportunity to ask more questions, the company does present more of the fundamentals of its plans for the next year or two years. However, Wesfarmers has always been adept at concealing elements of its strategy from competitors. It's not uncommon to find that a little less has been said than at first seemed to be revealed. And on occasion, what seems to have been said is not quite what was really said.

That's one side of the Strategy Days. The other side is that, especially for Bunnings, the top executives do deliver some of the most dense, and at times the most profound, statements about the basics of how these businesses intend to operate. They can often be a kind of very modest, but nonetheless ambitious, operational manifesto.

For Bunnings, these manifesto-like statements reference what is perhaps the deepest part of its DNA. Bunnings' most closely held belief, as nourished by its former CEO, John Gillam, is that "nothing is deserved, everything must be earned". The Strategy Day introductory statements are, at their heart, a reiteration of this belief, and a careful listing of the ways in which, in the coming financial year, the retailer intends to (again) earn the trust, loyalty and engagement of its customers, its staff and its suppliers, as well as acceptance by the communities in which it operates.

The manifesto delivered this year by Michael Schneider, who has replaced John Gillam as both managing director of Bunnings Australian and New Zealand (BANZ), as well as overall CEO of Bunnings, including Bunnings UK and Ireland (BUKI), was particularly dense, and deserves close parsing and interpretation. In HNN's view it presages some more difficult times to come for not only Bunnings, but also for home improvement retail in general.
Smaller stores

Before getting into this deeper view, it is best to start with something on the lighter side of the Bunnings presentation. As remarked above, while this Strategy Day was largely a type C affair, there was a dash of the type B, which in this case is all about a little bit of "misdirection" by understatement.

We saw something of this in the response to what was a good question from respected analyst David Errington, Bank of America Merrill Lynch, Research Division - Head of Consumer Research for Australia and Asia. Mr Errington asked:
The one area that I've really been interested to watch in the last five years is the flexibility in your format. I mean, John [Gillam] always used to say, and you used to say, you're not a cookie cutter, but you're taking that to new dimensions like the Collingwood store. With the carparks all around the place, it didn't seem to be a typical Bunnings, but you seem to be a lot more flexible now in where you're putting stores. You can put car parks on the roofs. You can put them underground. You can do anything you like.
What's the sales density of these new type of formats? Are they comparable to a typical 15,000 to 20,000 square metre one out in the sticks or - and do they - what sort of return metrics are they? And going forward, what sort of proportion are we going to see with these new type formats that are outside of the norm of what we expect the Bunnings Warehouse to be?

Mr Schneider replied:
The Bunnings stores we open - so Bunnings Warehouse will always be the big box, big stock, big box, stores that you know. And the Bunnings stores are our small format.
For a long time, we had formed a view that the future was only warehouses. We revised that in the last probably six or seven years, to say the small formats play an important role. They play a role in going into a market to get the communities to having a Bunnings store in the area before you migrate to a warehouse. We've done that a few times where we have them, with the feeling 'well, we couldn't get anything else in Collingwood.' So we took the old credit building and turned it into a Bunnings store.
So from a format point of view, I'm pretty agnostic. I think if we can get the numbers to sort of work, and Richard [Goyder] and Terry [Bowen] touched on some of the sort of modelling that we do, then we can get in and get going. It's great, and some of them are good infill, particularly as traffic in major cities gets worse on weekends, and they're very convenient during the week for charities to drop in and get the things that they need. In terms of productivity, they perform really well. Some will be better than others and some of our warehouses also have high stock turn.

Well, there is nothing wrong with that response. However, the underlying reality is that Bunnings is engaging in some really experimental new formats, such as the store it has proposed for the inner-Sydney suburb of Rozelle.

Where the Collingwood store does a good job of compressing the content of a Bunnings Warehouse to a "pocket edition" that covers most of the needs for that area, the proposed Rozelle store would seem, based on its plans, to offer lower stock density and more amenity in an urban environment. It even includes a turntable in the delivery area, to reduce the problem of turning trucks in urban traffic:
Service vehicles (up to 12.5m long) will be provided with a turntable to turn within the site enabling them to enter and depart in a forward direction and these vehicles will approach along Parsons Street from Crescent Street and depart along Parsons Street to Mullens Street.

It is a quite radical, and very interesting idea.

Any other retailer - just about - in Australia, given this question would have gone on about these new formats, what the company plans to do with them, their potential, other plans under development.

But not Bunnings. Not Bunnings, because the retailer simply does not see any real advantage in doing so. All it would be doing, we expect the Bunnings' view would be, is to increase expectations, telegraph strategy to competitors, and possibly increase local resistance to the development application.

In the end, if the store gets approval (the first version was rejected), the store will be built, and it will be judged on how it justifies that investment and satisfies the needs of its customers.

The next bit of this conversation with Mr Errington is just as masterful. He asks another very good question:
But going forward, say if your next 100 [stores], which arguably ... could be the rolled out in, say, five or seven years, how many of those would be warehouses compared to how many would be these infill type stores?

That question is fielded by Justin Williams, the incoming chief financial officer for Wesfarmers (replacing Terry Bowen):
Majority is still warehouses. It's still the preferred format, but where there's opportunities, where there's markets, as I said, where it's rightsized, then we take advantage of that flexibility.

The majority. If 100 are built over the next seven years, that's...well, it's 51, isn't it? Once again, the company answers, but it doesn't advertise its strategy, or limit its future options by much.
The manifesto

After carefully reading the introductory comments that Mr Schneider made at the Strategy Day, HNN has reached the conclusion that the Bunnings strategy for FY2017/18 - and possibly beyond that - is based on expectations of a flat to slightly reduced market for home improvement goods and services.

This does not mean that Bunnings is suggesting or forecasting a reduction in either revenue growth or earnings before interest and taxation (EBIT) growth. It does mean that the company will likely be making some changes to strategy and its approach to ensure it does deliver its expected good growth results.

Probably the most significant data point which could suggest this is Mr Schneider's careful description of the opportunity he sees for Bunnings arising from the exit of Masters:
In the last 12 months, we've seen some fairly significant change in the market with one large competitor closing down.
Accounting for range overlap, the differential in average pricing and the role of competitive marketplace on those dynamics, we see some opportunity for growth, but at a much more modest level than some analysis has suggested.

In fact, the number that Wesfarmers has suggested is 20%. The company is stating that Bunnings will pick up only 20% of the revenue that was going to Masters while it operated.

This gave rise to some questions from analysts. Bryan Raymond from the Research Division of Citigroup asked:
On the residual sales you expect to pick up from Masters' closure, I'm just interested in your workings how you got to 20%? It seems, given the crossover that amounts to 70% to 75% of the overall range, it seems like a relatively low number. I would be keen on [understanding] ... how you got to your 20%.

Mr Schneider handed over to Mr Williams to respond.
Yes, 20%, consistent, obviously, with our market share, and it sort of really reflects the competitiveness of the industry. As Mike's slide showed, there's a myriad of competitors out there.
So, the sales were built up. They came from a large number of competitors, and it make sense that they would be shared back between that similar suite of competitors. We don't expect to pick up large numbers of those sales. The industry is much more competitive than that. That's the reality of the industry, it's highly competitive.

Mr Schneider then picked up on this answer:
And probably on a unit basis, we - if you thought about gain on a unit basis, it might be a bit higher, but we've also invested significantly in price and we also recognise that there was a price differential between us and that business.
So if you normalise some of that, if you - how many hammers you're selling, as an example, it might be more than 20%. But in dollar terms, that's sort of where we see it planning.

He is suggesting that a Masters' customer might spend $199 on a cordless power tool, but an equivalent power tool might cost only $189 at Bunnings, so a 5% reduction in revenue would be built in.

It fell to Richard Barwick, an analyst with CLSA's Research Division to ask a key follow-up question:
I think your comment, Mike... was it "lower than some analysis that's out there"? Is that code for "the market's expecting too high sales in Bunnings over the next 12 months"?

Mr Schneider clearly denied this:
I don't think that we'd sort of suggest that for a second, I think it's really just about trying to make sure that we can give all of you and everyone listening in sort of a good sense of the mechanics and how we've worked out our numbers.

Without the kind of modelling Bunnings can do on its own business, but thinking through typical customer interactions and the dynamics of the market, it is just really hard to get to the 20% number for the transfer of sales from Masters to Bunnings.

The narrative that Mr Williams and Mr Schneider are suggesting is that a customer back in 2014 stops going to his or her local Thrifty-Link for drill bits, sandpaper, paint, nails, hammers and mitre saws, and switches to a nearby Masters. Two years later, after Masters closes, he or she then says "Righto!" and shows up back at the Thrifty-Link.

In support of this, there are, of course, some people who just do not like Bunnings, and will not shop there. But so strong a preference is quite rare. It seems that, in general, a more likely narrative is that customers who have previously sought out a big-box experience by shopping at Masters will, when Masters closes, transfer their purchases to the only other big-box in the market, Bunnings. This is especially the case given that some Masters stores are within 100 metres of a Bunnings, and most others tend to be less than a five-minute drive away.

Again, though, allowing for a two-month aftereffect of the Masters liquidation sale on the market, Bunnings does have modelling not only for March of the previous quarter, but probably for April and May as well. That is "low season" modelling, but it would still be telling.

HNN's prediction, in line with other analysts, was around a 60% pickup for Bunnings of Masters customers. We could assume that is too high, and 50% is more likely. Given that, the only way that HNN can make sense of this prediction is to suggest that what is going on is that the Masters market (which was tilted towards more affluent consumers) will itself see a contraction, of around 35% over the FY2015/16 demand. Combined with a (to be generous) 10% price difference, that would mean overall potential demand was 90% of Masters demand, further reduced to 58.5% by a decline, with Bunnings then picking up, overall, around a 29% gain.

Of course, all this eventually just becomes a game of numbers and assumptions. If we are lucky, five or more years from now we'll be able to look back and have some clarity about the shape of the market.

What is very clear, however, is that the outlook is essentially pessimistic. Neither Mr Williams nor Mr Schneider is saying "Well, there was an 8% differential in price between Masters and Bunnings, but that will be wiped out through increased demand".
Competition

The exchange reported above also brings up another feature of Bunnings' presentation at the Strategy Day. The reason why Bunnings will get less share of Masters' revenue is, Mr Williams tells us, the competitors in the market.

Mr Schneider made repeated references to competition in his prepared remarks. A standard slide Bunnings uses in its presentations showing the logos of its competitors has swelled considerably to include about 200, where in the past it listed a more modest 60 or so.

He began by stating:
...as competition increases and the broader addressable market is further explored, we must ensure we're listening closely to what our customers are asking for as well as evolving our offer to reflect the changing landscape of our industry.

His fullest statement about competition came mid-way his remarks:
In stark contrast to what many people talk about, we see and experience a market that's incredibly competitive. It has a wider range of specialists, mass merchants and category killers. Whilst many have a strong physical offer, many others have a strong online presence, and increasingly, we're seeing both. By focusing on ensuring we have a winning offer and drive our real focus on having the lowest prices, we continue to work really hard to ensure we have the products, the prices and the service that allows us to compete effectively regardless of format.

Later he stated:
We take no competitor, and I mean no competitor, local or global, physical or digital for granted. We are never complacent. If we ought to be successful, we must continue to give great value and fantastic experiences to our customers, and in doing so, be chosen by them.

These remarks are, on face value, quite true. Competition has increased in the home improvement market. The main independent hardware groups, chiefly Metcash's Independent Hardware Group (IHG), and the smaller Hardware & Building Traders (HBT) as well, have realised that whatever other advantages they offer, they need to start by having the best supply chain possible. Beacon Lighting has optimised its business, Reece continues to dominate some sectors in bathrooms, and retailers such as Sydney Tools offer low power tool prices online, and are expanding their physical presence.

However, it should be noted that the main reason why Bunnings has so many competitors in so many markets is that it keeps entering new markets, and taking considerable market share away from the incumbents. A business will certainly gain competitors through that strategy, but it is not as if it is beset by competitors popping up out of nowhere.

It is possible that both in these remarks, and in its remarks about gains from Masters, Bunnings is dealing with a concern that the Australian Competition and Consumer Commission (ACCC), which has been active recently in the home improvement sector, might be wary of how much market share the retailer has now gained. Even a simple suggestion by the ACCC that Bunnings should limit its future expansion could be damaging.
Leaner times

While concerns about some kind of regulatory intervention may have shaped a narrative that sees Bunnings depicting itself as a little less strong than it really is, HNN does still believe that underlying this is a genuine concern about a weakening home improvement market.

Bunnings would not be alone in this. The Housing Industry Association (HIA) is forecasting (as of 8 March 2017) volume growth in renovations of 2.0% in 2017/18, and 2.7% in 2018/19. The Reserve Bank of Australia (RBA) has also suggested that the "interest rates and equity windfalls" may be balanced by increased concern over the future. Writing in its "Statement on Monetary Policy" for May 2017, the RBA noted:
A substantially weaker housing market could have broader implications, including slower growth in consumption and dwelling investment than expected.

The way in which the company looks at gains from Masters' exit wasn't the only indicator of a Bunnings strategy geared to delivering ongoing growth in a down market. In the opening part of his prepared statement, Mr Schneider made reference to delivering:
...strong and sustainable returns across a variety of economic conditions. Working to stay nimble and responsive to what our customers are looking for is evident in the consistent track record of performance that Bunnings has continued to deliver.

In addition to this slightly unusual comment, there are three areas of focus that come up which indicate Bunnings may be gearing up for tougher times.

The first is an increased focus on existing customers, over gaining new ones. This isn't to say that Bunnings is not also seeking new customers and new markets, but where in the past that was a primary focus, the focus seems to have shifted to engaging more with customers the retailer already has.

The strongest statement about this Mr Schneider made was this:
Unsurprisingly, our strategic agenda remains the same. A deep and strong focus on the lowest prices, the widest range and the very best of service. In doing this, we ensure we remain absolutely focused on creating value for our customers over the long-term, and supporting these with physical and digital experiences that create inspiration and confidence to take on many types of DIY projects and do them in ways that create real values for the customers who do them. If we do these things, as I said, we get to be chosen more often, hoping to not only expand the market, but the degree to which we get to participate.

This is a well-known strategy for dealing with flat or declining markets. Gaining new customers in new markets carries upfront development costs, which can take a year or two to recapture. Convincing existing customers to buy more or from a wider variety carries lower costs.

The second element is what Mr Schneider has termed "better use of capital".
Bigger products and the changing technologies, store formats and the ability to use our capital more effectively to create better, even more convenient store offers or being more productive to invest in more value for customers.

Later he states:
Supporting this, we'll continue to improve operating efficiencies, lowering both our operating and capital spend on a per-project basis, meaning we can drive our growth agenda even more efficiently.

Referring to new stores and the rollout of new store formats, he said:
Trials across the last year on using capital more effectively and efficiently in these sorts of projects has been really pleasing to us and will form part of their model going forward, which enable us to do even more work with less capital.

In a down market, conserving capital is very important to providing good performance numbers. This is especially the case with Bunnings, which as a service/retailer, judges its performance using return on capital (RoC), rather than, say, return on net assets (RONA), which is more common in manufacturing.

Finally, there is Mr Schneider's focus on efficiency. This is an area where he has long been acknowledged as an expert. The recent shift in Bunnings Warehouses to combine the kitchen ordering, special orders and information desk into a single staffed in-store unit is typical of the clarity he and his team bring to this task.

Mr Schneider is also an enthusiastic supporter of using technology to improve both efficiencies and customer experience:
We're finding even more ways of using our tech platforms to improve efficiencies in the business from HR to supply chain to in-store tools to make our business even easier to run.

And:
Simplifying processes, using apps and other technology, such as mobile point-of-sale will ensure even faster and more enjoyable experiences in store.

It goes almost without saying that pursuing efficiencies is a really key strategic move in a down market. It is a fundamental to ensuring growth continues.
Community

Not associated with market conditions, this was perhaps the most surprising feature of Mr Schneider's address: he re-emphasised the need for Bunnings to be more engaged with the communities in which its stores operate. The word crops up no fewer than six times in what he had to say.
By working hard to be trusted by our team, our customers, suppliers community and of course, the wider market, we continue to ensure that the sincere and genuine way we participate in both the broader market and local communities is maintained. And the customers are willing to choose to shop with us because they understand and they appreciate it.

Later he said:
And our plan reflects this. It focuses on even better experiences for both our commercial and consumer customers and in the communities, which our stores are and our teams live.

As well as:
Speaking about stores, the unique environment of our stores is something that we know our customers really enjoy. And doing more to bring our stores to life and participate even more in the community in which we operate will be core to the engagement we want to continue to build with our customers.

HNN is sure that Mr Schneider and his team, like all good retailers, has a strong and genuine desire to engage with the communities where he does business, in a way which reaches beyond the store itself. It could be equally true, however, that the campaigns run by small retailers of all types is having some effect on customers' attitude to shopping at larger, corporate-owned stores.
Product lines

In terms of hints as to what new product developments can be expected from Bunnings, the slide presentation did call out a new outdoor power equipment offering from Honda. It also suggested that Bunnings would be continuing to market smarthome, LED lighting, and assisted living items for ageing Australians.

Perhaps one of the more interesting hints at what is coming is a couple of references Mr Schneider makes to "big products":
We'll continue to expand our reach through rolling out an online offer that supports and grows our already substantial special orders offer, enabling customers to buy large products in areas, such as playgrounds, sheds, outdoor structures, mature trees, bulk landscape, all of these in an online platform.

This is only part of this article. To read the remainder, please click on the link:
HI News Vol. 3 No. 7: Bunnings Strategy Day

Until next time,

Betty

You can contact me directly via email betty@hnn.bz or Twitter @HNN_Australia

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