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Big W versus Target and Kmart

Woolworths (ASX: WOW), owner of the Big W retail chain, and Wesfarmers (ASX: WES), which owns both the Target and the Kmart retail chains, have had to contend with a mild winter and ongoing price deflation. Of the three businesses, Wesfarmers’ Target chain appears to be the one causing the most headaches.

At the recent full year results presentation, Woolworths’ management reported that Big W’s growth within a number of important categories, including apparel, had helped increase its market share in the discount department store sector.

To achieve this growth Big W has introduced a number of innovative measures in recent years, from technology-focused mobile apps and a ‘click & collect’ option to the expansion of celebrity labels, including Peter Morrissey home and apparel ranges, Michelle Bridges and Guy Leech active ranges. All these initiatives have helped to lift the number of items sold by 9%.

Big W managed to grow sales 2% to $4.383 billion and expand gross margin by 1.02% to 32.74%. Gross margin expansion helped to increase earnings before interest and tax (EBIT) by 5.5% to $191.3 million, implying an EBIT to sales margin of 4.36%. The business reported a solid return on funds employed of 20.2%.

Let’s turn now to the two discount department stores owned by Wesfarmers. Managing Director of Wesfarmers, Mr Richard Goyder, described Target’s earnings as “disappointing” and affected by price deflation, clearance of excess inventory and increased costs.

Target’s revenue decreased 2.1% to $3.658 billion and EBIT plummeted 44.3% to $136 million to place the business on a 3.7% EBIT to sales margin. In stark comparison, Kmart managed to increase sales by 2.8% to $4.167 billion and boost EBIT by 28.4% to $344 million on an expanded margin of 8.3%.

These results led return on capital (ROC) at Target to fall from 8.4% to 4.6%, while at Kmart ROC increased from 18.9% to 25.9%, placing Kmart on the same ROC as the jewel in Wesfarmers’ crown, Bunnings.

Kmart achieved sales growth through lower prices and a continued drive for cost and process efficiencies. Obviously the strategy at Kmart appears superior to that being currently employed at Target. Looking forward, Target’s management is focusing on “getting back to basics” with a strengthened leadership team and long-term transformation strategy.

Foolish takeaway

From an investment point of view it is interesting to not only compare Big W against its competitors Target and Kmart but also to compare Target with Kmart. Wesfarmers’ impressive retailing ability and the returns being generated by Kmart should leave Wesfarmers’ shareholders comfortable that Kmart’s returns can improve.

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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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