When Wesfarmers (ASX: WES) purchased the Coles business back in 2007 for $18 billion, many analysts cheered the move, while others remained sceptical that the conglomerate could turn around the Coles business — which encompassed not just Coles supermarkets but also Target, Kmart and Officeworks.
Fast forward five years and opinions are still split. The company's full year results for financial year 2013 show that much of the retail business is still struggling to deliver a satisfactory return on capital (ROC) to shareholders. The results also show however that on the whole metrics are moving in the right direction.
The Coles supermarket division, under the guidance of Ian McLeod, has doubled earnings before interest and tax (EBIT) over the past five years and expanded the EBIT margin by nearly 2%. ROC is now 9.5% — still too low — but up from 8.7% a year earlier and significantly up from 2009 when it was just 5.1%.
The Office Supplies (Officeworks) division achieved ROC growth of 1% to 8.1%. While revenues stayed relatively flat growing just 1.6%, EBIT grew 9.4% and the EBIT margin expanded to 6.2%.
The turnaround at Kmart has been admirable. Management has undertaken a significant restructuring of the business which improved EBIT by 28%. In turn ROC increased to 25.9% up from 18.9% in 2012.
In comparison, the Target division was by far the major disappointment of Wesfarmers' retail businesses. ROC fell from 8.4% to just 4.6% as revenues fell 2.1%, EBIT tumbled 44.3% and the EBIT margin contracted to just 3.7%.
Finally, the Home Improvement (Bunnings) division has been an outstanding performer for Wesfarmers for many years and indeed it was the company's skill and success here that played a part in management's decision to acquire Coles. The division maintained its company-leading ROC at 25.9%, which interestingly was exactly in line with Kmart's ROC.
Foolish takeaway
The rise in dividend and the capital return will no doubt please many shareholders, however, a more detailed analysis of the results show that operating metrics still need to improve substantially within many of the retailing divisions. These metrics, with the exception of Target are moving in the right direction however returns below Wesfarmers' cost of capital are value-destroying so shareholders should what these metrics closely.
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
