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Will Lowes stick with Masters?

Woolworths (ASX: WOW) may be facing a bill of up to $800 million to buy out Lowes’ 33% stake in the Masters and Danks hardware joint venture.

According to the Australian Financial Review (AFR), Lowes has a put option currently valued at $631 million, but the value could rise to between $750 and $800 million by October 2014, when the option expires. Lowes was entitled to exercise the option this month, but agreed to extend it out for another year – underlining its commitment to the joint venture.

The value of the option is expected to rise as new stores are rolled out over the coming year, and new sites acquired, while existing stores mature. Masters and Danks compete against Wesfarmers’ (ASX: WES) Bunnings and the Metcash (ASX: MTS) owned Mitre 10 hardware stores. But it has not been smooth sailing for the new joint venture, with Woolworths admitting it had made mistakes in the hardware wholesale operations, by overestimating sales and gross margins, underestimating labour costs and getting some of its product range wrong.

Masters’ 31 stores lost $157 million in 2013, well above Woolworths’ estimate of $119 million, while Danks posted earnings of $18 million, well below the forecast of $38 million. But despite the losses, Woolworths remains confident the business will break even in 2016, five years after the first store opened. Woolworths is aiming to have 90 stores open by the end of 2016, giving it scale and won’t need aggressive sales growth to become profitable.

Woolworths is targeting 150 stores within five years, and currently has 120 sites, but analysts have suggested the market for DIY hardware is close to reaching saturation point, and the company may be forced to rethink its original strategy.

Foolish takeaway

It seems likely that Lowes will continue to roll over its option and hold on to its 33% stake in the Masters and Danks joint venture. With Australia’s housing market rocketing along, home improvement is likely to drive strong sales and Lowes may be keen to capture some of that before it exits.

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More reading

Motley Fool writer/analyst Mike King owns shares in Woolworths.

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