Australian analysts report on impact of Wesfarmers Homebase purchase

Following Wesfarmers half-yearly results on 15 February, Australian financial analysts have given their view on how the £340m purchase of Homebase in January 2016 has impacted on the overall business.

Wesfarmers reported a net profit after tax increase of 13.2%. The top performers were Bunnings, Kmart and Officeworks. Supermarket Coles reported lower earnings. 
Mcquarie Wealth Management Research said: "Bunnings UKI H1 losses were due to seasonality and restructuring charges. Winter in the UK is not conducive to DIY projects and gardening. The EBIT loss of £28m included £13m of restructuring charges to leave an underlying loss of GBP16m. The -2.6% EBIT margin is modestly larger than prior period margins of -1.2%, reasonable considering the turnaround task being undertaken across the Homebase network. We forecast a small loss in FY17 (despite a generally higher margin 2H) as the restructuring gathers pace."
Goldman Sachs retained a 'buy' rating for Wesfarmers shares, praising the conglomerate's diversified model.
Deutsche Bank Markets Research said: "Wesfarmers has reported a slightly better-than-expected result. The composition was largely as we thought it would be, with a sharp recovery in the industrials business, strong results from Bunnings and Kmart and a weaker result from Coles. However, the earnings decline from Coles was more acute than we had forecast.
"We see further downside risk to Coles earnings given its sales are growing slower than its underlying costs, with the resultant operating deleverage likely to be compounded by the requirement to invest more heavily in price. With Coles accounting for c. 40% of earnings, we believe this will weigh on stock performance and retain a Sell rating."
It added: "Management expects to execute four pilot Bunnings Warehouse stores in FY17 in UK and Ireland, and continue to reorganise the underlying business to facilitate low cost and high capacity operations. Management noted that the progress made so far in UK & Ireland is in line with the first phase of the previous acquisition plan."
UKI managing director PJ Davis said on this week's results: "As we have previously outlined in the acquisition overview, we're focused on building strong business foundations in our phase 1. We're delivering good retail basics by introducing higher stock weights and wider assortments of core home improvement and garden products whilst also investing in price.

"The first stages of team development the cultural changes required are well progressed with the majority of store management completing key leadership programs. In addition, we've built the infrastructure to develop and operate the first tranche of pilot stores with the St Albans opening earlier this month and at least three more to follow by the end of June 2017. The pilot, like the majority of Homebase network, is right sized for the market with stores able to support warehouse merchandising principles so we can leverage a lower cost base to our advantage. We're looking forward to opening and operating more pilot stores this year.

"We've made solid progress on phase 1, transitioning Homebase and opening our first pilot. Sales are broadly in line with the rebased business and post a number of restructuring costs and costs associated with a pilot, the business recorded an EBIT loss of GBP28 million. We have repositioned Homebase to Always Low Prices, to offer customers better value and develop a clear position for the business which enables it to perform better over the three to five-year transition to Bunnings.

"The transitioning of Homebase to all about building a strong foundation as a step towards creating the new Bunnings Warehouse business in the UK and Ireland. We have established core ranges of home improvement and garden and removed ranges of soft furnishings and bedroom furniture. The clearance of non-core ranges is now largely complete, enabling us to roll back a number of new ranges into the Homebase stores over the next 12 months.

"There has been further investment in stock with new ranges, the additional Bunnings Warehouse ranges and seasonal increase to ensure the business is better positioned for the important 2017 spring, summer trading period.

"We have also see transactions increase by 9.1% on a like-for-like basis across the period. This number has obviously been positively impacted by the significant clearance activity we've undertaken. However, we're also encouraged by the customers' response to the new and expanded ranges we have now introduced.

"As we commented at the June strategy day, our leadership team in the UK is now well established and we're supported by an advisory board which is assisting us with strategic insights to the local market. In addition to a number of leadership development programs, we've conducted service training for over 10,000 of our team members. Additionally, what we've really invested in is making sure our store teams know that we care and we want to empower them to do a great job into the future.

"Our supplier base is now engaged with our business, supporting the new expanded ranges and now rolling out product knowledge and accredited training programs. As we expected, there's been substantial disruption in the process of integrating Homebase into Bunnings and the Wesfarmers Group which involves transitioning and separating Homebase from its previous owner. Separation is well advanced, with the majority of the transitional services terminated, with three large projects remaining in home delivery, including a call center and IT system.

"We will continue to see trailing transitional costs until August this year. Agreements have been reached with all concession holders for an orderly exit and the process of physically removing the concession is ongoing. The agreements to remove concessions means that we can rapidly move to phase 2 of our three to five-year strategic agenda.

"Negotiating a rapid exit of concessions has been challenging but successful and we're clearly focused on preparing for the roll-out of Bunnings Warehouse throughout the United Kingdom and Ireland. If we could now move to the next slide, please. There are a lot of things that are going to hold us in good stead, but one thing stands out with the effort; that the effort has gone into engaging with our store teams and supplier base, inviting them to be part of something that's very exciting. We've had great support from our supplier base, both locally and internationally which has enabled us to deliver the widest range of global market leading brands.

"Proof of pilot is obviously a critical step to further investment and we will take our time to get this right. The first of these stores open on February 2 as part of the plan to have at least four pilot stores opened by the end of June. We have had great customer feedback and the early results are pleasing.

"We've talked about our long term ambitions; we've talked about the three-phase plan and we're still in phase 1. This is a period of consolidation and trial. As we reset Homebase, we're working hard to establish market leading Bunnings Warehouse stores and the success of these stores, it is an absolute precursor to any further investment in the roll-out of our network development plan.

"I think in summary we've seen a solid start. Much has been achieved through hard work by our team."

Analyst David Errington said the UKI Bunnings loss "must be a concern", adding: "But a AUD48 million first half loss and AUD29 million of that, trading loss. Can you give a bit of colour as to why that is? Because the full year earnings of Homebase was AUD40 million profit. How - where did that loss come from? That sort of like came out of the blue for me."

Davis said: "I don't like making losses. Look, we previously advised that as we rebase the sales we'd lose about GBP200 million turnover on the old business.

"We also did foreshadow that this acquisition - during the acquisition and transition there was going to be a lot of disruption as we fundamentally repositioned the business. Now we're going through this at the moment so we can build a really strong foundation for Bunnings Warehouse throughout the United Kingdom and Ireland. It's a large market.

"We're very excited about the prospects that we're seeing but there is a lot of change and there's cost involved in those changes as we build higher stock weights, wider assortment, we've invested as we had to do in price within Homebase. So it is there, the strong foundation, as we build the business over the next five years. We've always said, early part will be significant transitional costs and swings."

He added: "There's been significant restructuring costs. We're moving out of concession, we're in transition. The underlying trading performance of Homebase is getting stronger all the time. We saw 9.1% increase in transactions. We're getting good feedback from customers. But that 9.1% too was driven largely by a lot of discounting activity where we had to clear out a lot of stock at very low prices.

"We're not seeing it weak in home improvement. We saw borrowings for housing at record highs in December and we're expecting the market to grow. If you have a look a bit deeper, the Government's recently announced a rollout of a large housing investment in public housing.

We're just resetting the cost base at the moment. We won't finish the transitional services agreement until August. They're quite a drag on earnings at the moment and we've got to re"-set up - as you know set up new IT systems, new deliver platform and we're rebasing the costs around our call center right at the very moment. So this is a pretty big transition that we're going through.

Bunnings MD Richard Goyder added: "There is a seasonality to it so we would expect the half we're in now as PJ alluded to, going into spring and summer we'd expect that to be a stronger performing season than the half we've just been in.

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