Wesfarmers-Bunnings 2017-18 H1 results
Bunnnings Australia powers ahead
Bunnings results for fy2017/18 first half
Bunnings results for fy2017/18 first half
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Wesfarmers could refocus further investment into Bunnings, but not in its traditional business areas
HNN Sources
On 20 February 2018 Australian conglomerate Wesfarmers announced its results for the first half of FY 2017/18. This followed on from an announcement two weeks prior that it would make a writedown of over $1000 million for losses and revaluations associated with its Bunnings United Kingdom and Ireland (BUKI) operations, and its Target department store operations based in Australia.

Following on from this, on 16 March 2018, Wesfarmers announced its intention to "demerge" the operations of Coles, a supermarket, convenience store and liquor business based in Australia. While Bunnings was not directly involved in the demerger, Wesfarmers managing director Rob Scott did comment on how this move would affect the home improvement retailer, both as an individual division, and through some company-wide initiatives that will be implemented.
Company results

Revenue for Wesfarmers improved mildly, reaching $35.903 billion, up by 2.8% on the previous corresponding period (pcp), which was the first half of FY2016/17.

One-off, significant items had an impact of $1237 million on earnings before interest and taxation (EBIT), and an impact of $1323 million on net profit after tax (NPAT). This meant that EBIT fell by over 54% as compared to the pcp, and NPAT declined by 86.6%.

Excluding the significant items, EBIT was $2350 million, down by 3.3% on the pcp, NPAT was $1535 million, down by 2.7%, and basic earnings per share fell 3.2% to $1.356.
Divisional results

EBIT for Coles fell by 14.1% on the pcp, to reach $790 million. Department stores (Kmart and Target) lifted EBIT to $415 million, up 7.2%. Officeworks returned $68 million in EBIT, up 9.7%. The consolidated industrials division of Wesfarmers returned EBIT of $449 million, up by 19.1% on the pcp.
Bunnings Australia & New Zealand

Sales revenue for Bunnings Australia & New Zealand (BANZ) was $6566 million, up by 10.22% on the pcp. EBIT came in at $864 million, up by 12.21%. Total stores sales growth was 8.8%, up from 8.4% in the pcp. Store-on-store (comp) sales growth was 7.5%, a full percentage point above the pcp's 6.5%.

The managing director of Bunnings, Michael Schneider, introduced the figures for BANZ by saying that the consistent and strong results from BANZ were pleasing.
The business has demonstrated strong momentum, delivering growth across consumer and commercial, in all trading regions and categories. It is worth noting that sales in the corresponding prior period were affected by a late start to spring, and the stock liquidation activities of the Masters business. EBIT increased as the business remain focused on cost control, and we continued to drive value for customers. Ongoing favourable property market conditions led to positive outcomes on property divestment. Higher earnings, and a continued focus on disciplined capital management resulted in a 7.9% improvement in return on capital, which reached 46.94%.
Our ongoing focus on even better customer experiences was supported by the completion of even more store upgrades, and category refresh work, in addition to further investments in customer value. During the period 11 new trading locations were opened, including eight new Bunnings warehouses, two smaller formats stores, and a trade centre.

According to supplemental information, BANZ now has 253 warehouse stores, 77 smaller format stores, and 33 trade centres. NSW has 74 warehouse stores, VIC 57 and QLD 42. New Zealand has 21 on the North Island, and six on the South Island. Four warehouses were closed during the half.

Mr Schneider continued to outline some of the strategic priorities for BANZ:
The business remains committed to three key areas in our strategic agenda. Creating better experiences for customers through deeper engagement in store and within our local communities, as well as accelerating our digital capabilities, as reflected in the recent launch of the extended range online that I will speak to shortly.

Focus also continues on strengthening the core of the business, including driving safety across all areas.

As of late February, Bunnings in Victoria now offers the opportunity to purchase items from its "special orders" range directly online. This a graduated step, as essentially all that has happened is that the mechanism of ordering has shifted from a verbal process to a digital one, with other aspects, such as picking and shipping, likely remaining unchanged. Products that can be ordered via this process include much of Makita's 12-volt power tool line, as an example.

BANZ has also introduced a means of checking for in-store stock online. The details appear when items have been looked-up on the Bunnings website. This indicates if a product is available, is available only in limited numbers, or is not available. Early testing of this feature by HNN indicates that there are a few flaws in stock-tracking by Bunnings: items that appear on the database as being in-stock - especially older items - can sometimes not be found in the warehouses themselves. That's only to be expected on the introduction of such a system.

Respected retail analyst Michael Simotas of Deutsche Bank asked Mr Schneider how much of the improved performance was due to internal changes, and how much was due to external influences on the pcp which might have depressed those comparative results, such as poor weather and the effects of high levels of discounts at Masters Home Improvement as it exited the market.

Mr Schneider responded that it was likely a combination of different factors that had led to the good result for the half.
I think we talk consistently about the way we model pricing in the business, seeing gross margins go down, which we have been very successful at doing over quite a long period now. [That] upstream work has downstream benefits in productivity gains and efficiencies in-store. [That includes] the use of technology, and more reliability around the stock flow process, particularly going into Christmas.
Obviously, as we cycle out of deep clearance activity from other players in the market, that will shift reactions to things, but it is not about putting prices up. I think we were very clear during the Masters clearance time, that that was clearance activity, so we didn't really move on pricing then, in response to that, and obviously that has meant that we have been able to continue to invest in pricing now.
For the weather point of view, it is obviously an impact when you get sustained, challenging weather conditions, and that shifts the mix of products which will obviously shift the mix of prices and margins. But really it is all about continuing to invest in the value proposition for the customer through productivity improvements, and also product innovation, as well as improved buying practice. So I think when you build some of those together, it delivers some solid outcomes for you, as you can see in the result.

In a similar vein, an analyst from Goldman Sachs asked about whether changes in the property price cycle in Australia can be expected to have more of an effect on BANZ. He suggested that, while in the past Bunnings had been underexposed to these changes, its shift to a larger, more diverse store network encompassing a wider market, might make it more vulnerable.

Mr Schneider replied by pointing out that the products BANZ sells are quite diverse.
Some of those are necessity, as I said before, and some are discretionary [purchases], and that takes place across both consumer and commercial (effectively the trade market). So that does give us a degree of flexibility.
There is no doubt that when housing churn is high there is a benefit to be gained, because obviously everyone is doing something to their home before they sell it, and the new owners then want to do something to it to make it their own. But the reality is, as housing prices have grown, and it becomes very expensive to swap out of one property to another - and from our research I think overall lending values on a lot of established mortgages are actually quite low - there is a desire and appetite for Aussies and Kiwis to invest in their own homes to make them a better place to live.
So we sort of see a degree of resilience that comes through from from that. We don't, or normally I wouldn't talk about regional performance. The sort of challenge that I have with the team is that we want to perform better than the market. So if the market is negative, and we are less negative, then we see that as a positive outcome. And if the market is going well, then we want to be performing on the high side of that.
Bunnings UK & Ireland

As highlighted at a special presentation at the start of February, performance at BUKI has been very poor for the half. EBIT was almost 2.5 times worse than in the pcp, and revenue fell by 15.7%. As has been described in the previous edition of HI News, this has led to a large writedown in the BUKI business, and to Wesfarmers undertaking a review as to whether the business is worth continued investment. The result of that review will be released at the Wesfarmers' Strategy Day in early-June 2018.

Challenged by respected Morgan Stanley Bank of America analyst David Errington on whether the delay of four months was justified, and might result in further harm to the Wesfarmers business, Mr Scott replied that he did not think reports of the demise of BUKI in the British press should be taken too much to heart.
The first point I would say is that I would be careful [not] to draw too many inferences or conclusions from what you read in the British press. The facts that we are more influenced by are what our team members are saying, what our suppliers are saying, and we do engage very closely with our suppliers.
Clearly the news we came out with the other day is disappointing for us, and disappointing for shareholders - as well as disappointing for the BUKI team. I think what you will find, and this feedback has certainly been reiterated to us through Damian McLoughlin, and the team on the ground in the UK, we've been very open and honest about this, we've been upfront as a group, we've said we've made a number of mistakes. What we're doing to remedy that is to strengthen local talent, and really starting to listen to our local team members. [We are] making sure we have people over there running the business that really understand the UK market.
That honesty, and that openness, has been very well received by the team. And we are actually finding some good support and action there off the back of that openness.

Mr Scott went on, in response to Mr Errington's original question, to offer some insight into his thought processes over waiting for a review and, in effect, giving the Homebase operations of BUKI a chance to trade out of the situation they are currently in.
It's really easy, David, as a new CEO to come in and just wipe the slate clean. I do not think that that is necessarily in the best interest of our shareholders. Where we sit today, the best thing we can do right here right today, is to improve the trading losses, and that is what we are focused on.
So the team in BUKI are absolutely focused on reducing the cash losses, setting the offer up, we've got a lot of stock there, and were coming into a really important trading period, through spring and summer, and let's make the most of this opportunity.
Obviously we have some broader strategic questions, and I've been very clear that we will update the market on that in June. I don't want to preempt that. So the focus short-term: reduced losses, improve trading performance, and irrespective of what we choose to do, post June, we will be in a much better position in June if we can reduce those trading losses.

On further prompting from Mr Errington as to whether the announcement itself was unhelpful to BUKI's future prospects, Mr Scott finished the topic by saying:
We set the bar pretty high at Wesfarmers, particularly around capital allocation, and frankly we just have to take it on the chin, right? We have to take it on the chin, that we made a few mistakes, we are disappointed by that, and we are happy to cop a bit of flack. But what is most important is that the decisions we take from here on in are in the shareholders' best interests.
Bunnings UK pilot stores

In that spirit, Mr Schneider was thorough and accurate in recounting the problems that BUKI is facing. However, he did point to what he regards as positive signs when it comes to the Bunnings UK format stores that are being slowly rolled out by BUKI.
We had 15 Bunning's pilot stores trading at the end of the half. We continue to receive positive feedback from our customers, and really good engagement from local communities. We have worked hard to ensure that we are offering the widest range of trusted brands, and we have been pleased with the strong supplier support we have received. The performance of the pilot stores is encouraging, although as Rob said earlier this month, the growth did moderate over the winter months, and we are now looking to see how the pilots perform during the peak spring summer period.

He went on to outline more of the process that is in place to thoroughly test the different formats and approaches of all the pilot stores.
We currently have 19 of these open, with a further five to be opened by the end of the financial year. We have an assortment of pilots with a range of formats, size, capital spending and market environment. We will carefully analyse and monitor the performance of each pilot to help inform our future plans. There is clearly a lot of hard work ahead of us, and I will give you an update on our progress at the strategy day in June.
Revitalising Homebase

Both Mr Scott and Mr Schneider pointed to Wesfarmers' efforts in securing more local knowledge and experience in the Homebase team as being crucial to at least radically reducing the losses in that store network. Mr Schneider in particular highlighted the addition of Mr McLoughlin and ex-Officeworks executive David Haydon to the management team as being important.
Over the last six months, a lot of work has gone into identifying, attracting and recruiting talent in areas such as merchandise, supply chain, and store development. We now have a greater depth of talent, more attuned to the local market, and a structure that allows for improved clarity of responsibility, and accountability.
The combination of Damian McLoughlin, and David Haydon, with strong merchandising and operational backgrounds, and knowledge of the UK market are a real positive, and a good complement to the rest of the team. We've also sharpened up merchandising, promotion and operational plans to drive better performance, and place significant emphasis on much improved execution in all aspects of the business.

Mr Schneider also went into more detail about the planned reduction in the size of the Homebase store network.
In terms of the Homebase network, we have closed five loss-making stores in the first half, and are currently undergoing a more comprehensive review of the store portfolio.

Elsewhere Mr Schneider affirmed the planned reduction in the size of the network:
There is also significant amount of work going into looking at the store portfolio of Homebase. As Rob called out two weeks ago, a detailed review is underway and likely to result in the closure of 20 to 40 stores.
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HI News Vol.4 No.2: The hardware activist
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