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US partner arrives to review Woolworths’ hardware chain

It looks like the cavalry has arrived in Australia with a report by BusinessDay that the Chairman of Woolworths’ (ASX: WOW) US-based joint venture partner, hardware giant Lowe’s, has flown in for scheduled talks.

Just under a month ago, Woolworths was forced to update the market on the Home Improvement division’s performance in the face of increasing market speculation of cost overruns and underperforming stores.

The update confirmed many analysts fears, with management advising that earnings before interest and tax losses of $139 million from the division were now expected —  significantly higher than the previously forecast $81 million loss for financial year 2013. This loss included a reduced profit of $18 million, compared with $38 million forecast for the Danks business and a larger than forecast $157 million loss for the Masters business.

The estimated size of the home improvement market is $42 billion with the Woolworths/Lowe’s joint venture posting sales of $1.2 billion in the year to June. In comparison, Wesfarmers (ASX: WES) owned Bunnings accounts for around 16% of sales; meaning the market is still highly fragmented and ripe for further consolidation.

The market share that the Masters business has achieved from a standing start in a short space of time is not to be sneezed at. For example, Reece Australia (ASX: REH) a firm which has carved itself out an enviably profitably niche within the plumbing segment and been in business for nearly 100 years, has sales of just over $1.5 billion.

Foolish takeaway

The stock market and many investors are an impatient lot. The market dynamics and Woolworths’ retailing skills make a move into home improvement a sensible one and one which offers a reasonable avenue for growth. It is of course critical that management ultimately creates and does not destroy shareholder value by achieving reasonable returns on invested capital in the Masters business. These returns however will need to be judged over a number of years – even decades – not a 12-month start-up period.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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