With Woolworths (ASX: WOW) entering the home improvement market through the acquisition of the Danks business and the establishment of the Masters retail chain, Woolworths is now in direct competition with Wesfarmers' (ASX: WES) highly regarded Bunnings business.
Masters is still in the early stages of its store roll out program and is forecast to experience start-up losses until at least financial year (FY) 2016. While it is difficult to fully judge the two businesses against one another at present, it is still interesting to compare the two.
In line with the previous year, return on capital within the Bunnings business was an outstanding 25.9%, while the trading EBIT margin expanded from 11.6% to 11.7% over the financial year. This led to Bunnings producing earnings before interest and tax (EBIT) of $904 million on sales of $7.661 billion which was a 7.5% increase in EBIT from $841 million on sales which increased 7% from $7.162 billion in FY2012.
Even though Bunnings is a large and established chain the growth profile is still sound. Same store sales growth was 4.4%, with growth in commercial sales a highlight at 9.6%. Bunnings management continued to open more stores, for a total of 23 new stores over the year. The breakdown in store type was 10 warehouse stores, 10 smaller format stores and 3 trade centres. During FY2014 management expects to open at least 20 more warehouse stores.
The Masters chain experienced further start-up EBIT losses, which increased 40.8% from $96.7 million in FY2012 to $138.9 million in FY2013. While not disclosing actual sales numbers, management admitted its original sales budgets had been too optimistic. However for stores opened at least 12 months, sales targets are in line with "the business case sales target."
Given the fixed costs involved with warehousing, distribution supply lines and support network, expected losses per Masters' store are declining as the fixed overhead base is absorbed over a larger number of new stores. The benefits of lowering the average fixed costs per store are significant, making progress on the roll-out closely followed by analysts and investors. Woolworths had opened 31 Masters' stores by the end of June with a further 18 stores planned to open during FY2014 putting the roll out on target to reach approximately 90 stores open by FY2016.
Foolish takeaway
Woolworths' management is forecasting that losses from Masters in FY2014 should not exceed the FY2013 losses. Management also reaffirmed its expectations that it can reach a break-even point during FY2016. The returns on capital and profit margins earned by the established Bunnings business are impressive. Given Woolworths' skill and experience at retailing, the potential benefits from a profitable Masters business which could flow to shareholders over the medium term should not be underestimated.
Woolworths and Wesfarmers are owned by many income-seeking investors, however there's an even more enticing dividend paying stock available. Discover The Motley Fool's favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."
More reading
- What will drive Westfield's growth?
- Watch out bakers and pizza makers, Woolworths is baking up growth
Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
