Has Wesfarmers Ltd made a huge costly mistake?

Wesfarmers Ltd (ASX: WES) could be facing the prospect of multi-billion dollar losses on its expansion in the UK home hardware market according to one analyst.

Wesfarmers is the industrial conglomerate that owns Coles, Kmart, Target, Bunnings, Officeworks and a host of other diversified businesses.

Seeking to capitalise on its strengths in Australia in home improvement through its Bunnings warehouse stores, Wesfarmers announced the acquisition of UK home improvement and garden retailer Homebase in January this year for £340 million (A$705 million). Homebase is the second-largest home improvement chain in the UK behind market leader B&Q – which is owned by Kingfisher – Europe’s largest home improvement retailer and the third-largest in the world.

Wesfarmers also announced that it would spend more than $1 billion rolling out the Bunnings brand in the United Kingdom and Ireland.

But not everyone is enamoured by the group’s overseas expansion – with BAML analyst David Errington comparing the move to Woolworths Limited’s (ASX: WOW) Masters disaster. Woolworths entered the Australian home improvement market through a joint venture with Lowe’s, but it was doomed to failure from the start, wracked by many issues, not least of which were wrong products, wrong target market and placement of stores (right next to a Bunnings?) left a lot to be desired.

Woolies also announced the sale or closure of Masters in January this year – within days of Wesfarmers’ Homebase announcement – and demonstrating the dissimilar fortunes of the two home improvement ventures. The move is likely to cost Woolworths billions, but at least does cut off a business that was bleeding losses.

As Mr Errington said earlier this week, “We were critical towards Woolworths entering the Australian home improvement sector via Masters and we believe Wesfarmers entering the UK market via Homebase will be as equally a compromising decision for Wesfarmers.”

Mr Errington also questioned whether Wesfarmers had overpaid for Homebase, given the UK retailer generated just $40 million in earnings before interest and tax (EBIT) or a multiple of 17.6x which is very high.

UK market leader B&Q has 330 stores in the UK and Ireland, but is in the process of rebranding and refocusing its strategy under its Screwfix brand, according to some reports.

Foolish takeaway

We’ll have to wait and see whether Wesfarmers has the right strategy to succeed in the UK with its Homebase acquisition – but considering the strengths of Bunnings in Australia and how Masters struggled to compete suggests Wesfarmers is going to be a tough competitor for the UK’s existing home improvement retailers.

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Motley Fool writer/analyst Mike King owns shares in Wesfarmers and Woolworths. You can follow Mike on Twitter @TMFKinga

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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