Bunnings/Homebase investor reaction: "A lot of changes already made" but still "a lot of work to do"

Deutsche Bank and UBS have reported on a UK Bunnings/Homebase investor tour, saying there has been a promising start but returns could take longer than management expects.

Bunnings held a UK site tour and presentation this week a year after its Australain parent company bought DIY/garden centre chain Homebase for £340m.

Investors saw St Albans' revamped store and another unconverted Homebase. Nine further pilots are opening this year.

They said Bunnings has copied the Australian store model at St Albans, but were cautious in their predictions on when Bunnings UK and Ireland will make a profit.

Deutsche Bank Markets Research gave a 'sell' rating and said:  "A lot of changes have been made, not only to the pilot store but also to the Homebase fleet, where unwanted categories have been exited and range has been broadened. We were struck by how similar the Bunnings pilot is to Australian stores, not only in format but also the presence of a large number of Australian brands. The store was relatively busy, certainly more so than our recollection of the first Masters store in Australia, but it is early days and the format is unproven in the UK. It also remains to be seen whether British consumers will take to Australian brands.

"Overall, we think Bunnings has great people and culture in the UK and is taking a ‘test before invest’ approach. However, we see risk that it could take longer than hoped to generate acceptable returns, even if the Bunnings format resonates well, given the challenging economics of the Homebase formats. A lot of work still needs to be done and in particular the key bathroom and kitchen categories need to be sorted out."

Deutsche said Homebase had experienced weak sales in this area after moving from discounting to 'lowest prices'.

Deutsche added that the b&Q ‘one Kingfisher’ approach has helped Bunnings to pick up some key global brands like Osram.

It added: "While management has been reluctant to offer a transactional online service in ANZ due to the poor economics, they seem to accept it is necessary in the UK. Homebase already had a transactional website but the Bunnings brand is unlikely to implement this for 18 months. The Group will lead with a build out of rich web content in a similar manner to ANZ."

UBS said: "The key message [of the tour was] the opportunity is material, progress is being made and medium term.

"Return on invested capital (18%) and CAPEX (cA$1b) targets are unchanged. Our key takeaways were: i) UK is a large, growing market ripe for consolidation: £38b market (1.6x Aus), with the top 2 players holding <15% share;

ii) Industry behaving rationally: There has been little competitive responses to date to BUKI price cuts, with a weaker GBP likely to see inflation in the market, near-term;

iii) New Bunnings looks like the Australian format: The first pilot in St Albans has, while still early days, been a success with 9 more pilots planned by year-end;

iv) WES is investing where it counts: Price (Every Day Low Pricing), range (brands & SKU’s +40%), and service (including online). Overall Wesfarmers looks to be executing well, albeit we believe the ability to turn a profit in the second half of 2017 is low.

"Earnings implications: Medium term targets unchanged. Medium term ROIC (18%) and CAPEX (cA$1b) targets for the BUKI business were unchanged, implying financial year 2021 EBIT of c$290m (UBSe $151m).

"We continue to sit below management guidance, reflecting:

i) It may take longer to turn a profit with losses likely to continue in 2H17 (UBS view);

ii) We are yet to see a competitive response, which could put pressure on margin; iii) High fixed cost business means profitability will be heavily reliant on lifting store productivity.

"The above said, we believe the stores look good and came away more comfortable with the opportunity after hearing from management.

"Neutral unchanged: Positive signs but too early to tell. We were encouraged by the investment being undertaken, the depth of management and positive (albeit early) feedback on the first pilot Bunnings store in the UK. The above said, the division is unlikely to be a material contributor to the group for a
number of years and we make no changes to UBSe -c$20m loss in 2H17 for BUKI, with break-even in 2H18. Our key concern is risk that losses continue through FY18."


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