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Woolworths’ $1.1 billion property challenge to Bunnings

Despite Woolworths (ASX: WOW) reporting a $138.9 million loss from its Home Improvement division for the financial year ending June 2013, according to a report published by Fairfax media, Woolworths and its joint venture partner, the US-based giant Lowe’s have a land bank and property portfolio worth $1.1 billion set aside to continue the roll out of the Masters’ store chain.

As of FY 2013, the roll out of Masters’ stores had seen 31 stores opened with another 18 planned for FY 2014. With 120 sites currently active and an aim to secure 150 sites within the next few years, it is easy to see how such a large land bank has been built up.

While the scale of Woolworths’ move into hardware is enormous, with the joint venture already reporting revenues of over $1.2 billion, the challenge for Woolworths is not just that the Wesfarmers (ASX: WES)-owned Bunnings’ chain has over a two-decade head start on Masters but that it has major expansion plans itself. According to the Fairfax report, Bunnings “has its own plans to invest $1.5 billion in up to 78 new stores over the next three years to defend its dominant position in the hardware sector.”

Given the home improvement market is estimated to be around $42 billion in sales domestically and Bunnings produces a mouth-watering 11.8% earnings before interest and tax margin on sales, it’s no wonder that Woolworths wants a piece of the pie and equally unsurprising that Wesfarmers will rigorously defend its position.

Foolish takeaway

As often is the case in retailing, scale is a key contributor to profitability. As Woolworths noted in the FY 2013 presentation, Masters’ losses per store have declined as expected as the fixed overhead base is absorbed over a larger number of stores.

With moderate growth in sales per store, improvements in gross margins and improved store efficiencies and fractionalisation of distribution and support costs, Woolworths is expecting it can reach breakeven point for Masters during FY 2016.

With Bunnings producing nearly $1 billion of earnings to Wesfarmers; if Woolworths can get its move into hardware right, the benefits to shareholders are obvious.

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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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