How Woolworths Limited got caught between Bunnings and a hard place

The share price of Woolworths Limited (ASX: WOW) has failed to hold on to gains made in the immediate afterglow of the announcement that it will sell or wind up its loss-making home improvement division.

On Tuesday, the stock closed 1.3% lower at $23.35 which erased some of the gains made on Monday when an announcement regarding the decision was released.

While the key focal point now for investors is gaining an understanding of the costs Woolworths will endure in extricating itself from the hardware business, it can also be instructive for investors to look back and review just how it came about that Woolworths ended up in such a predicament in the first place!

One only needs to take a look at the phenomenal success of Bunnings, owned by Wesfarmers Ltd (ASX: WES) and the salivating operating metrics of that business to understand why Woolworths’ board and management would have been tempted to enter the Australian hardware market.

Consider these facts:

  • Australia’s home improvement market is worth over $40 billion per annum
  • Last year’s store-on-store sales growth at Bunnings was 8.8%
  • Bunnings return on capital for the 12 months ending 30 June 2015 increased to 33.5% from 29.3% in the prior year
  • Bunnings revenues and earnings before interest and tax (EBIT) in financial year 2015 were $9.5 billion and $1.1 billion respectively
  • Bunnings EBIT margin was 11.4%

With metrics like these there is little wonder that Woolworths was tempted by the opportunity to take its sourcing, logistics, marketing and retailing skills which have been so successfully applied within its supermarket business and utilise the skill set within the hardware sector.

In hindsight, despite the seemingly attractive growth opportunity, Woolworths failed to successfully execute its plan.

To rub salt into the wound, on the same day that Woolworths announced it was pulling the pin on Masters, Wesfarmers confirmed its acquisition of the UK-based retailer Homebase. However, whether Wesfarmers’ growth endeavour within the UK hardware sector turns out to be ultimately successful, only time will tell.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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