30/11/2011 - 10:33

Performance key to rewards at Wesfarmers

30/11/2011 - 10:33


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Changes to Wesfarmers’ remuneration policies have shone a bright light on the company’s results.

Changes to Wesfarmers’ remuneration policies have shone a bright light on the company’s results.

WESFARMERS has been one of Australia’s most successful companies during the past two to three decades, and one of the mantras that served it well was a strict focus on return on equity.

Whatever business it was in, and whatever growth strategies it pursued, had to meet the group’s exacting performance hurdles.

If one of its business divisions was not performing, it was restructured or sold.

Against that background, many people were surprised last month when Wesfarmers proposed changes to managing director Richard Goyder’s long-term incentive plan.

Under the plan, Mr Goyder was eligible to be granted a series of performance rights each year.

Those rights would ‘vest’ only if the group met what it called a “challenging” performance hurdle; specifically, a return on equity of 12.5 per cent in two consecutive years.

The group did not meet that hurdle last year, and shows little sign of reaching it. Therefore it proposed an alternative, based on total shareholder returns.

This prompted some of the Wesfarmers alumni scattered across Perth’s business scene to ask if the problem lay with the incentive plan, or with the company strategy.

Some of these people have referred back to a presentation that former managing director Michael Chaney delivered to Wesfarmers’ best practice conference in 1999.

The title was: ‘Wesfarmers performance focus: its roots and sustaining features’.

In the speech, Mr Chaney explained the importance of return on equity.

“We adopted it as our principle (sic) performance measure at the corporate level and set a target of 15 per cent as a ‘satisfactory’ level of performance, given that only the top 20 per cent of companies achieved that historically,” he said.

In order for the group to achieve this return, after adjusting for corporate overheads, each division had to achieve an 18 per cent return on capital.

Any business division achieving 18 per cent or higher was encouraged to expand their business, subject to new growth initiatives meeting performance hurdles.

If the return was between 10 and 18 per cent, the business had to prepare a three- to five-year rectification plan. The minimum return on capital was 10 per cent.

“This was defined as the level below which we would rather liquidate the business and repay debt,” Mr Chaney told the conference.

What constitutes a satisfactory return on equity in the current market is a point for debate; the answer to that depends on trends in interest rates and inflation. 

But even Mr Goyder (pictured, above left) concedes that Wesfarmers’ 7.7 per cent return on equity last financial year was not satisfactory.

“We do need to lift that,” he told a press conference when announcing the annual results in August.

The key to Wesfarmers’ performance is its retail businesses, which have dominated the group ever since the 2008 purchase of Coles.

Coles supermarkets, Kmart, Officeworks and Target are now pivotal to the group’s fortunes, along with the established and highly successful Bunnings business.

Since 2008, the performance of the old Coles businesses has been vastly improved, with assurances there is more good news to come in future years.

“We’re on track and ahead of the acquisition case,” chairman Bob Every (pictured, above right) told shareholders at last month’s annual meeting, when challenged on the merit of paying $20 billion for Coles.

That did not satisfy shareholders who recalled the group’s 2007 performance, when return on equity was 25 per cent and the share price reached $42 (compared to about $31 today).

The big problem facing the group is that while earnings are rising, its equity base – the denominator in the ROE equation – is also much larger, as a result of discounted share issues during the GFC that were needed to fund the Coles business and reduce its debt.

In fact, Wesfarmers’ capital base has tripled to about 1.2 billion shares and its shareholders’ funds have risen from $3.5 billion to more than $25 billion.

What then, is the outlook for Wesfarmers?

Brokers agree that net profit will rise solidly over the next few years, as the group continues to get more value from its Coles food and liquor business.

Patersons has forecast that net profit will rise from $1.9 billion this year to $2.65 billion in 2013.

UBS is not quite as positive, forecasting it will take until 2014 for reported net profit to reach $2.61 billion.

That would see return on equity rise to 9.7 per cent – better, but well below the old 12.5 per cent performance hurdle.

Following the annual meeting, the performance hurdles that Mr Goyder now faces are aligned with standards widely used at most other listed companies.

His share awards will be subject to two performance hurdles: the growth in the group’s return on equity, relative to that of the S&P/ASX50 index; and the group’s total shareholder return, once again relative to the companies in the top 50 index.

In both cases, Wesfarmers must exceed the 50th percentile before any of the applicable shares will vest; and must reach the 75th percentile before all the shares vest.

The new scheme is also subject to a four-year performance hurdle.

Most shareholders ended up voting in favour of the new scheme, with backing from ISS Proxy Advisers and CGL Glass.

Shareholders supported both the remuneration report and the granting of share awards to Mr Goyder and finance director Terry Bowen.

In Mr Goyder’s case, he will be awarded $6.7 million worth of shares.

That is on top of his base salary ($3.4 million last financial year, including superannuation), and his annual bonus ($2 million last financial year).


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