The problems faced by Woolworths Limited (ASX: WOW) in 2015 were part of arguably the longest running bad news story of the year. Multiple profit downgrades, the announced departure of the CEO and upheaval at board level with suspicions that senior leaders were out of touch with modern retailing all conspired to deliver a terrible year.
But thankfully, 2015 is now in the rear view mirror, and the major challenges facing Woolworths can now probably be summarised by a few simple words: Masters, BIG W and the CEO.
Number 1: Masters
Masters was supposed to be the project which starved Bunnings of its oxygen. No one at the Bella Vista headquarters of the company thought that Masters would become the number one hardware player quickly, but in a multi-billion dollar hardware and renovations market, surely there was room for two large players.
Unfortunately, poor decisions on ranging, unfavourable locations and a botched store roll out strategy have seen the business become an anchor on the rest of the Woolworths group, draining other areas of capital and management attention. The loss-making division has also experienced widening deficits despite several years of focus, a sign that has alarmed many investors and analysts.
In 2016, management needs to decide on the right course of action for Masters: double down on investment and really hang in there for the long haul, or sell the business and move on.
There are two complicating factors. Firstly, Masters is actually a joint venture, with US hardware giant Lowe's holding a one third share in the business. Secondly, selling Masters would not be as simple as setting up a "for sale" sign and waiting for offers, as there would be few buyers willing to buy the business as a going concern.
Instead, the parts would likely be sold piecemeal. The business holds hundreds of millions of dollars of inventory, buildings and land, and a sale would be a long-term process that would take months.
Number 2: Big W
Just as Bunnings has left Masters in the dust, Target and Kmart have begun to steadily improve as Big W has declined. The problems are similar, with poor stock choices and management's musical chairs hampering the business.
However, Big W now has a proven leader in Sally Macdonald, formerly of OrotonGroup Limited (ASX: ORL) on board to help set the strategy required for the turnaround. Despite this, rumours persist that Woolworths is readying Big W for a sale so it can focus on its core supermarkets business.
The general merchandise category is competitive, subject to volatile discretionary purchasing levels and low margin, so it may make more sense to divest Big W rather than persevere with it, as it is unlikely to deliver stellar returns over the long term for shareholders.
Number 3: The CEO
In my opinion, the most pressing issue for Woolworths to put right is to fill the CEO chair. Without this position being filled, the rest of the company is in a holding pattern to maintain the status quo, as a new leader is likely to shake up operations and bring a new strategy.
However, it is fairly clear that the status quo is not helping anyone who holds shares in Woolies. Competitors are not standing still while Woolworths drifts, and Aldi and Coles are consistently taking market share and recording better same store sales growth, respectively.
The new CEO could come from two broad camps, someone with deep experience in retail and / or fast moving consumer goods, or alternatively, a leader who is a standout performer in another industry like services or logistics, who can bring a truly fresh set of ideas to the business.
Either way, the sooner a call is made the better, and the share price will likely track sideways until some certainty is gained.
At the end of the day, the reason to deal with these three problems quickly is so that management can focus on the core business, the underperforming supermarket division. When that engine is firing again the business may once again be able to grow its return on equity sustainably. The myriad other issues facing the business are far less important in comparison.
