The BUKI Billion Blitz
Time to press the "pause" button?
Wesfarmers managing director Rob Scott
Wesfarmers managing director Rob Scott
 
click for next slide
click for first slide
click for last slide
click for next slide
Rob Scott, the new managing director of Wesfarmers, faces his first major challenge with its loss-making BUKI unit
HNN Sources
Australian retail, mining and chemical conglomerate Wesfarmers announced on 5 February 2018 that it was taking what amounts to a $1.026 billion write-down on its home improvement retail operations in the UK & Ireland.

The trigger for the write-down was that Bunnings UK and Ireland (BUKI) suffered an accelerated loss during the first half of FY2018. BUKI produced estimated pre-tax losses of $165 million for the period from 1 July 2017 to 31 December 2017. This contrasts with a market forecast of losses of $110 million - for the entire 2018 financial year.

The core reason for this write-down, according to Bunnings, was a decline in its retail sales from mid-November to the end of December - or, to put this in more accurate and less euphemistic terms, BUKI saw sales collapse during the core of the Christmas retail season. While that decline included both the 240 stores that are still branded as Homebase as well as the 19 Bunnings pilot stores, the company says it intends to concentrate on improving the returns from the Homebase network over the coming year.

Wesfarmers' response to this failure has been to launch a review. According to a statement issued by Wesfarmers:
A review of BUKI has commenced to identify the actions required to improve shareholder returns. The review is focused on options to improve the trading performance of Homebase as well as further evaluating the performance of the pilot stores to inform the future plans for BUKI.

The recently appointed managing director for Wesfarmers, Rob Scott, is quoted in the statement as saying:
We will take a disciplined approach to further capital deployment in BUKI and provide an update on the outcomes of the business review and our plans for a broader conversion to Bunnings at our Strategy Briefing Day in June.

The current managing director of Bunnings, Michael Schneider, is reported as making the following comments in the statement:
It is clear that a significant amount of change has been driven through Homebase since the acquisition and the disruption caused by the rapid repositioning of the business has contributed to greater than expected losses across the Homebase network.
Sales have been affected as non-core categories and concessions were exited ahead of the implementation of the Bunnings format, and investments in price and new ranges have not offset these lost sales. Trading was particularly weak during the latter part of the first half of the 2018 financial year.
Our focus is on improving the profitability of Homebase through improved ranging and execution in stores, while continuing to develop plans for a broader conversion to Bunnings. The team has been strengthened, including through the addition of strong local expertise, to support improved outcomes.

The same statement also announces the retirement of the managing director of BUKI, Peter (PJ) Davis. Mr Davis is being replaced by BUKI's chief operating officer (COO) Damian McGloughlin. Mr McGloughlin was recruited in mid-2017 from Kingfisher's UK home improvement retail operation B&Q, where he had worked for 34 years. Former Officeworks executive David Haydon, who had previously been appointed as general manager at BUKI, will step into Mr McGloughlin's former position as COO.

Mr Scott offered a valedictory comment on Mr Davis's retirement, stating:
PJ has been instrumental in driving the growth and success of Bunnings for the past three decades and in the establishment of the Bunnings Warehouse format in Australia in the 1990s.

The statement reported a comment from the current managing director of Bunnings, Michael Schneider:
Mr Schneider said he was grateful for the contributions Mr Davis has made to the Bunnings organisation and the culture of the business.
Presentation

The media and ASX release gave notice of the write-down itself and the departure of Mr Davis, but Wesfarmers made use of a combined investment analyst/media presentation to more fully articulate a general change in the direction of its strategy for BUKI.

This event was hosted by Mr Scott and recently-appointed Wesfarmers chief financial officer (CFO), Anthony Gianotti. Held on 5 February 2018 at 11am AEDT, this 80-minute event began with an eight-minute introduction by Mr Scott, followed by 45 minutes of questions from analysts, and finished with 25 minutes of questions by members of the mainstream media, including News Limited, Reuters, and several reporters from Fairfax Media.

While Mr Scott gave some strong indications of a change of direction in BUKI's strategy, the discussion contained only hints of what might actually happen over the coming four months. Mr Scott's repeated answer was to say that the review mentioned earlier would have to be concluded first, with decisive action to be announced at the June 2018 Strategy Day.

That said, what Mr Scott did deliver was an early preview of some of the analysis the company has made of exactly what is going wrong with BUKI, indicating the areas where the retail operation needed to change. Those areas were:
  • The operations of the refitted Homebase stores.
  • The importance (or unimportance) of kitchens.
  • The strategy for the conversion of Homebase stores into pilot Bunnings UK stores.
  • Refitted Homebase stores

    Much of the discussion during the presentation about the poor performance of BUKI as a whole concerned what Wesfarmers now regards as poor choices made in the rapid refit of the Homebase stores in the year following their final acquisition in April 2016.

    In general terms, the new Wesfarmers viewpoint is that as Homebase was profitable when it was acquired by Wesfarmers, it should either have been left alone, or undergone only mild, and slow changes to its retail offer. This was spelled out fairly clearly by Mr Scott in response to a question by a Morgan Stanley analyst, who asked whether Wesfarmers should simply "pull the plug", and abandon the entire enterprise. Mr Scott responded:
    It certainly would not be the preferred outcome. What we are mindful of is that a lot of the issues we are dealing with today have been, to be frank, self-induced. Two years ago Homebase was a business that was profitable. We now have a team that understands the UK market, we have a number of opportunities to improve performance, and that is very much what we are focused on. But all options are open, and we will go through this review in a very detailed way, with a very strong focus on improving performance and reducing the cash losses. We will be able to update on the outcomes of that review in June.

    This followed on from some of the introductory remarks of Mr Scott, where he stated:
    In summary, the trading losses [at BUKI] are a function of lost sales of exiting ranges such as kitchens, bathrooms, and decorative lines, together with various retail concessions. The expansion of ranging in core home improvement categories, together with a significant investment in price, did not offset the loss of sales and margins as a result of these changes ... The initial strategy was to rapidly reset the Homebase business, to facilitate conversion to Bunnings. The pace and nature of this change was not well received by traditional Homebase customers.

    Later, in a response to a question by J.P. Morgan retail and consumer analyst Shaun Cousins on the difficulty in returning Homebase to profitability, Mr Scott expanded on what he sees as the faults in the handling of the Homebase refit:
    It is premature to be giving guidance, and the focus of this review that we are undertaking is really to better inform us on the opportunities and the actions that will improve profitability. So we will have more to update in June.

    While I think that conceptually the decision to exit various retail concessions was probably the right decision over time, the pace at which we exited those concessions, and the failure to present other range, other products that resonated with Homebase customers really contributed to some of these losses.

    Mr Scott is placing blame for the failure of the Homebase transformation on both execution and strategy, in particular the rapid shift in customer base. This is a sharp change in Wesfarmers' approach. From the time of the original acquisition up until the last annual results presentation for Wesfarmers in August 2017, the strategy of rapid and radical transformation of Homebase received support. At the annual results presentation for Wesfarmers in August 2016, this is how then-Bunnings Group CEO John Gillam described what was happening at Homebase in his prepared remarks:
    We've rolled our sleeves up, and dived into a comprehensive and rapid repositioning of the Homebase business. From our due diligence work we knew that the business we acquired had a poor and confusing offer, with very low stock availability and low stock levels. New trading strategies have been formulated and implemented across merchandising, pricing, marketing and operations. We are exiting all non-core product, as well as removing all the concession operations in the store network. The offer is now very firmly focussed on the home improvement and garden market.
    To support the repositioning we have invested approximately GBP60 million to both widen product choices and increase stock depth. We have also completed a restructure of the support team, and incurred costs associated with the repositioning agenda. This has resulted in GBP30 million in costs in total, and the modest EBIT result we reported for the period is offset by that amount. The Homebase team is energised by the opportunity, and we have commenced a strong supporting investment program aimed at developing our new team.
    All this work is essential to creating the platform we need to implement our acquisition plans. We are pleased that the inevitable disruption has been well-managed.
    Encouragingly we have seen store transactions increase by 7.5% on a like-for-like basis across the period of ownership, and that trend has continued at a similar level into July.

    One specific area that did come in for some criticism was the failure of Homebase to provide the right seasonal products for winter. In response to an analyst's question, Mr Scott said:
    As I said earlier there are clear seasonal differences there. To be frank it's not surprising that if we don't have the right product in-store at the right time that it is going to impact our sales. Clearly we haven't got that right.
    As I mentioned earlier, categories such as storage, cleaning products, are particularly important to these months. Also heating, lighting, some of the adjacent categories to kitchens and bathrooms, such as tiling, flooring, and plumbing.
    All of these categories are increasingly important in the winter months, and really comes back to having the planning in place, to ensure you have the stock in-store at the right time and that this aligns with your promotional activity. Clearly we did not have that in place through the winter months.
    The importance (or unimportance) of kitchens

    Those who have been following the progress of BUKI will know that one of the main faults revealed by Mr Davis was a difficulty in selling the Bunnings idea of a kitchen, both at the Bunnings UK pilot stores, and in the Homebase stores. At the analysts' presentation for Wesfarmers FY2016/17 results, Mr Davis, responding to a question from respected Merrill Lynch analyst David Errington, stated:
    To be fair we didn't expect to lose the volumes in kitchen and bathrooms that we did. All right. So some of the strategic moves and the repositioning of the business have had impacts that we didn't project into the future. But we are re-establishing that right now.

    He went on to add:
    So we are going through a major transition in relation to kitchen and bath. Key principles are that we do not want to support one of our major competitors, in manufacturing, key principles are that we want a simple execution. We have closed installation down because we don't believe that it is key. We believe that, people will tell you [that] you can't sell kitchen and bathrooms unless you install them. We'll go talk to some other big players in the world that don't install kitchen and bath, including ourselves in Australia.

    What was at issue here was that the UK and Irish kitchen market consists in large part of installed kitchens. According to the UK Houzz Kitchen Trends Survey for 2017 (the most recent), 49% of those surveyed employed a kitchen fitter, 47% employed a kitchen designer, and 33% employed an architect when building/renovating their kitchens. That contrasts with the numbers from the Australian Houzz Kitchen Trends Survey for 2017, which shows that only 32% employed a kitchen designer, and 14% employed an architect.

    Somewhat surprisingly, however, according to Mr Scott's comments at the recent presentation, not only has the kitchen problem been completely solved, but it also really was not much of a problem to begin with. In response to a question from a Citigroup analyst, his comment was:
    Kitchens have been problematic, but I wouldn't call them out as necessarily the most material contributor [to the loss]. What we found is that it took longer than we would've liked to come up with our new format around the kitchen offer. So this is more of the flatpack version, that you've seen in Australia. So it took a bit longer than we would've liked to actually get that in-store.
    We now have it in-store, it is selling, it is selling pretty well. We've seen some positive signs there. But we are dealing with a much lower average sell price, and we are obviously starting from scratch on this. So while there have been some encouraging signs with our new offer, we are starting off a very low base and it took quite a while to get it online.
    The other thing to remember is that there are a whole lot of other related categories, off the back of kitchens. Examples of that would be flooring, tiling, and plumbing, which really go hand-in-hand with the kitchen offer. And those three lines which I mentioned - flooring, tiling and plumbing - my view is that we don't have our offer right yet in those adjacent, related categories. So clearly more work to do still on kitchens, bathrooms, and related categories.

    In fact, the kitchens are doing so well, that their sales success has managed to cross the border from the Bunnings UK stores to the Homebase stores, as Mr Scott pointed out in response to a question from a Credit Suisse analyst:
    Just a very simple example of that is the new Bunnings format kitchens are actually selling quite well in Homebase. So the team has a sense of optimism around the opportunities.

    Of course, what might be going on here is something of a confusion about what "kitchens" means. For Mr Davis, kitchens would likely include at least the plumbing component, and certainly countertops, and so forth. Perhaps for Mr Scott, with more of a "numbers" focus on shareholder returns, "kitchens" refers simply to a specific set of stock-keeping units (SKUs).

    In any event, it remains puzzling that while the problems clearly associated with a major part of the UK home improvement business are being described as "not material", that same business has produced unexpectedly very poor retail sales results.

    It is perhaps worth noting that the UK kitchen comparison website kitchen-compare.com awarded Kingfisher's B&Q with the title of "Lowest Priced National DIY Retailer of Kitchens for 2017". According to the description on that company's website:
    For 2017, the "Lowest Priced National DIY Retailer of Kitchens" accolade has been awarded to B&Q for consistently having the most lowest priced kitchens when compared to Homebase and Wickes. Every day during 2017 we monitored and logged the prices of comparable kitchens sold by the UK's National DIY Retailers Wickes, Homebase and B&Q. We did this using a typical 8-unit kitchen model layout.
    Conversion of Homebase to Bunnings UK

    A major challenge facing BUKI is how, when and if it should continue to convert Homebase stores to Bunnings UK stores. On a scale basis, part of that challenge relates simply to cost. The current cost of conversions is running at over GBP2 million per store. Mr Scott suggested, in response to an analyst's question, that this cost could be cut in half:
    As you would expect in the early pilots you do tend to over-capitalise. For example the cost of removing mezzanines on a bespoke basis rather than at scale ... So you could use the number of around GBP2 million. But going forward, a number of the lighter conversions - which we feel will still drive a good improvement in sales density - are in the order of GBP1 million of cost per store.

    Additionally, in responding to another question, Mr Scott noted that the number of stores that would be converted is likely to be reduced as well.
    It has been clear through our review that there are a number of stores that we do not think will justify further investment by way of conversion to the Bunnings format, and indeed the losses generated from some of the stores are essentially holding the business back into the future. We have also found that through the Bunnings conversions, there have been some instances where we have delivered much better returns by closing an existing store and taking out a new lease on a better located better quality store. A good example is Folkestone.
    So the provision in relation to the store closures, we are talking about in the order of 20 to 40 stores. These generally relate to the stores that generate the greatest amount of operating losses, and where we have identified the potential for improved national outcomes for the group based on lease tenure and terms and so forth. So we will be able to update more on the outcomes of this review in June.

    Even with cost reductions and being more selective about store conversions, you would potentially be looking at, to be generous, 190 stores at GBP1.3 million each on average, which gives a total of close to GBP250 million, or $443 million (at current exchange rates). Added to that would be the cost of lease buyouts for the non-converted stores, so the overall cost would likely be over $450 million. While that expenditure would be spread out over two to three years, it is difficult to contemplate in the face of the over $1 billion that has already been spent to produce an underperforming network of home improvement stores in the UK and Ireland.

    This is an abridged and shortened version of this article. To read the full version, please download HI News Volume 4, Number 1 at:
    HI News Vol. 4 No. 1: The BUKI Billion Blitz

    (It's free, of course.)
    HNN Sources


    Bookmark permalink


    Click to visit the HBT website for more information