Wesfarmers cuts off costly tail

Wesfarmers’ decision to spin-off its Coles supermarket business marks a significant moment in the conglomerate’s more than 100-year history.

It also provides a fascinating window into the thinking of new CEO, Rob Scott.

I was always wary of the purchase of Coles, a process that started in early 2007 and was completed in 2008. The original deal came with the backing of private equity, but those partners disappeared as the signs of what became the GFC were emerging in the US.

In hindsight, Wesfarmers may well have been better off to pay heed to that signal. It closed the takeover of the struggling Coles business just as the GFC was starting to slam Australia. Although the GFC effects were short-lived in Wesfarmers’ home state, the revival of the national retail business – which was a lot more than supermarkets – was definitely hampered by the lack of consumer spending and confidence prevalent for far longer in the eastern states.

I would also suggest that Wesfarmers’ ability to capitalise on other opportunities created by the GFC were significantly affected by the need to digest Coles. Imagine a cashed-up Wesfarmers in late 2008 when Bankwest was part of a fire sale of assets by distressed global bank HBOS. Even Coles may have been half the price once the GFC hit.

Wesfarmers could easily have picked up some incredible bargains in the resources sector, not just in 2009 when resources was shaken badly, but in 2012 and 2013 when the likes of Fortescue Metals Group plumbed the depths of its valuations.

There have been domestic gas assets, and domgas production assets sold that may or may not have attracted more of Wesfarmers’ capital in circumstances that excluded owning Coles.

Admittedly that is all looking in the rear view mirror, and any speculation about what might have been is meaningless until we really calculate how much value Wesfarmers derived from the Coles purchase.

That will have to wait until the Coles spin-off is done and we see how the market values it on day one.

From memory, Wesfarmers spent $22 billion a decade ago and has pumped in an estimated $8 billion since. On the positive side of the ledger, it has received significant returns from the supermarket business it now proposes to eject from its stable at a valuation estimated to be $20 billion. It will also retain several businesses that came with the original purchase – Target, Officeworks and Kmart.

Whatever this number, I presume Rob Scott thinks there is little joy to be had from hanging on to Coles.

• Its recovery story is finished and its growth opportunities appear limited.

• Amazon and other e-tailers have yet to hit the fresh food sector but it must be around the corner and, meanwhile, foreign players such as Aldi are already eating Coles’ lunch.

• Woolworths has got its act together after thinking that it could get into the hardware business and go after Wesfarmers’ subsidiary, Bunnings, while the WA firm was focused on Coles.

Coles was the tail wagging the dog. An increasingly cumbersome asset that was hindering the key game of Wesfarmers – to use its scale, access to capital and business smarts to acquire and grow diversified businesses.

Mr Scott still has the UK debacle of Bunnings to contend with; who knows if turning that around isn’t worth more to Wesfarmers than having Coles on its books?

And the planned Coles divestment may write the script for other retail asset disposals. There has long been talk of exiting Officeworks and the jury is out on the long-term value of other retail assets, especially the struggling Target. Even Bunnings could go the way of Coles if this most recent plan works.

Just getting rid of Coles makes Wesfarmers a much smaller business. In its current form, it is around the seventh biggest business on the ASX, one of just two Western Australian companies in the top 20. Woodside Petroleum is the other. It is most likely Perth, regrettably, will no longer be home to two top 20 companies.

Will that push Wesfarmers below the radar, or prompt investors to pay more attention to its strategy?

As a smaller company, Wesfarmers can certainly look at a lower tier of options for material growth.