Hard-nosed realities of the hardware business

OPINION: Wesfarmers has received some positive news on its move into UK hardware, but things are less rosy for investors in the local property trust in which it holds a major stake.

Cold comfort as it may be for investors in its Australian property associate, BWP Trust, Wesfarmers’ ambitious adventure into the British hardware business has passed its first inspection by hard-nosed financial experts.

In the same week that a tour group of analysts was inspecting the first full-service Bunnings warehouse in Britain, the unit price of the ASX-listed BWP, originally known as the Bunnings Warehouse Property Trust, dropped to a 12-month low.

The difference between the celebrations when showing Bunnings in Britain to visitors from big-name investment banks such as Goldman Sachs, Credit Suisse and UBS, and the fall in the BWP unit price was a warning that Wesfarmers has some repair work to do at home – because it is the biggest investor in the property trust that owns most Bunnings warehouses in Australia.

During the past eight months, as Bunnings executives have been busy overseeing the rebranding of Britain’s Homebase chain of hardware stores acquired last year, the BWP unit price has fallen by 30 per cent from an all-time peak of $3.91 to last week’s low $2.74.

However, the key date when considering what has happened to BWP is actually August 24, the date Wesfarmers said it had struck a deal to take over 15 properties used by the failed Masters hardware business, causing Bunnings to vacate seven warehouses sites owned by BWP.

The effect of losing a premium client from the seven sites was immediate, and expensive, for BWP investors, who saw the unit price of their company drop from $3.56 the day before the exits were announced to $3.24 a week later – with the fall continuing because of uncertainty about the future relationship between Wesfarmers/Bunnings and the property-owning trust.

From the status of being an investment recommended by many investment banks, BWP has descended into ‘sell’ territory. UBS (one of the banks on the British tour of Bunnings) last week dropped its BWP recommendation from ‘neutral’ to ‘sell’, noting the shortening lease profile with Bunnings and the loss of Bunnings as a tenant in seven sites.

UBS’s view of Wesfarmers, written the day after its negative view of BWP, and based on its British tour, was more positive, though the investment tip remained ‘neutral’, largely because the investment in Britain remains small beer for Wesfarmers and early days for Bunnings in Britain.

There are, however, a few numbers that could have Wesfarmers shareholders wondering about the British expansion, and the time it will take to become a significant profit generator rather than a cost to the company.

Since Wesfarmers acquired the Homebase business for £340 million ($702 million) early last year, the value of the British pound has collapsed from more than $A2 to about $A1.60, which means that Homebase would be $158 million cheaper if the same price was paid today in pounds.

A similar sobering calculation can also be made about what has happened to the value of Wesfarmers’ 25.75 per cent stake in BWP, since the stock fell from its $3.56 price on the day of the Masters deal to the latest price of $2.76, with the difference being $128 million.

It can be argued that Wesfarmers is $286 million worse off because of the two deals (acquiring Homebase when the pound was high, and relocating Bunnings warehouse properties). But it can also be argued that the loss will be recouped by finding new tenants for BWP, and proving that Britain will be good for Bunnings as it rolls out stores and innovations such as online trading.

Finding tenants of Bunnings’ calibre will be a challenge for BWP, perhaps more than succeeding with hardware retailing in Britain, given the response of analysts who visited the first Bunnings warehouse in that country at St Albans in Hertfordshire, north-west of London.

Credit Suisse was cautious in its assessment of the British Bunnings, noting the big investment in inventory (stuff on shelves) and the ambitious target of having 10 warehouses by the end of the year. UBS said it expected the new business to post a loss this year, adding that it might take longer than management expected to generate profits. Goldman Sachs described the strategy of moving Bunnings into Britain as ‘sound’.

Investors in Wesfarmers should be pleased that professional analysts are impressed with the work so far in Britain, despite the currency effect on the initial purchase price of Homebase.

Investors in BWP will be hoping that Wesfarmers, as the major shareholder in their business, can repair the damage done by the loss of Bunnings as a tenant in seven of the properties it owns.