Both News Corp and Fairfax Media are reporting that Woolworths Limited (ASX: WOW) losses in its Masters Home Improvement business are getting worse. Unfortunately, they are both partly wrong.
Overnight, US hardware retailer Lowe's — which holds 33.3% of Woolworths' Home improvement business and includes both Masters and Home Timber and Hardware brands — reported a quarterly loss of $US15 million on its share of the Joint Venture (JV).
Deutsche Bank analysts estimate that the JV lost $67.5 million before tax in the last quarter, based on Lowe's most recent report. They say that is much worse than the $57 million loss for the same period last year. However, Masters has opened 13 new stores since then, which no doubt drags on earnings, so the analysts aren't exactly comparing apples with apples. Exchange rates have also jumped around since last year, with the Australian dollar falling from around US 90 cents to around US 71 cents currently.
Lowe's declared a loss of US$16 million in the previous corresponding period – a US$1 million movement is hardly something either Lowe's or Woolworths would be overly concerned about.
Another factor that the media reports seem to miss is that earnings aren't steady from quarter to quarter, and the next quarter is likely to be lower – as the chart below shows. March quarters appear to be the highest, followed by September, while December quarters are usually the lowest.
Suggestions that this is new evidence for Woolworths management to dump Masters is nonsense. Sure, the Hardware joint venture is losing money. In the last financial year, the JV reported an earnings before interest and tax (EBIT) loss of $224.7 million, up from $169 million the previous year, so it's plain to see for all.
But I seem to keep repeating this, which is that Woolworths' Home Improvement business consists of two different brands and strategies – Masters, and Home Timber and Hardware. At an EBIT level, Home Timber and Hardware is profitable. Masters might still be making losses, but the company says new store formats have increased sales by 30%, indicating that the business is heading in the right direction. That's a start though with my rough calculations showing each Bunnings store currently earns around twice that of a Masters store.
I still feel that Woolworths needs to persist with its Home Improvement offering, despite not liking Masters personally as a brand. When the market leader, Bunnings – owned by Wesfarmers Ltd (ASX: WES), has around 20% market share and generates around $10 billion in sales annually and EBIT of over $1 billion, there's plenty of scope for Woolworths to grow market share and become profitable.
Media reports that Bunnings would be interested in at least 15 Masters stores also suggests that Woolworths has at least got some locations for its stores right.
I'm sure Masters' management are working hard on several strategies to ramp up sales even further and get Masters to the stage where it is a profitable business. With just over 60 stores and most of them less than 3 years old compared to Bunnings' 337, Masters is also still building up to scale.
Foolish takeaway
Investors probably won't find out what Woolworths plans to do with Masters until a new CEO has been appointed, which could be some time away. If the company is truly looking long-term, they'll hang in there with the business. In 10 years' time, we may well be trumpeting the performance of Woolworths' Home Improvement business and the current issues long forgotten.
