It seems every article you read these days about Woolworths Limited (ASX: WOW) is yet another call by analysts to dump the underperforming hardware business Masters.
As usual, their focus is short-term, and the company is unlikely to acquiesce to their demands.
Simply taking a long-term approach to the DIY handyman and the home hardware market is more in the interests of shareholders, rather than looking for a quick win to appease unhappy shareholders and market analysts.
Bank of America Merrill Lynch analyst David Errington is one such analyst who has persistently been calling for Woolworths to jettison Masters as well as discount variety store Big-W.
This is the same analyst who predicted in 2009 that Coles would be unable to turn around its performance.
At the time, Coles' owner Wesfarmers Ltd (ASX: WES) was planning to spend $1 billion annually for five years to complete the turnaround of Coles. At the time, Woolworths was planning on spending twice as much.
As Mr Errington noted, "Given the planned actions of a major competitor that could, in our view, prove detrimental to industry returns, we think a Coles turnaround is unlikely."
Can you imagine how silly Wesfarmers would look now if they'd thrown in the towel then?
Mr Errignton has been dead right about one thing from the start though. Masters was always going to take longer and cost more than originally envisioned to reach profitability. And Woolworths have made several major mistakes with the Masters brand. Most consumers, particularly tradespeople, simply prefer rival Bunnings (also owned by Wesfarmers) for a number of reasons, convenience of location, brands and types of products it stocks, appeal, store layout, and a number of other factors.
Masters stores have been set up in the wrong locations, focused on the wrong demographic, has very few of the high-end brands like Bunnings stocks which alienates tradespeople, sells the wrong products, and often its store assistants lack knowledge of the hardware sector. Bunnings, on the other hand, seems to hire ex-tradespeople, with in-depth knowledge and experience.
But all of these issues can be fixed. New store formats are already producing results, some Masters stores will be closed, and Woolworths have indicated that they will slow the rollout rate to focus on growing revenues from existing stores.
The big question is whether new chairman Gordon Cairns and a refreshed Woolworths board will continue down that path. To exit Masters could cost the company hundreds of millions, when it clearly has a desire to remain in the DIY hardware business. Mr Cairns has repeatedly stress that the numbers will determine the decision.
As I've often suggested, Woolworths should scrap the Masters brand and re-brand all its hardware stores with its existing Home Timber & Hardware brand. Home Hardware stores are profitable at an earnings before interest & tax (EBIT) level and produce higher sales per store than Masters.
There could also be a number of other factors that determine whether Woolworths hangs onto Masters. Selling off Masters could see the new owners turn the business around – much like Dick Smith Holdings Ltd (ASX: DSH) has, after being sold for a pittance. Woolworths' board is unlikely to want egg on its face like that again.
Woolworths' Home Timber & Hardware would then face another competitor (if it was retained when Masters was sold) , or Bunnings could easily grow its market share by picking off the demerged company. It would also leave Woolworths with a much smaller market share of the DIY home hardware market, so the company would probably need to sell its Home Timber & Hardware stores as well.
Foolish takeaway
I don't expect Woolworths to exit the home hardware market just yet. It could take some time, but I still believe the best course of action is to persist with a long-term view of growing to profitability and gaining a meaningful share of the $43 billion home hardware market. But please get rid of the Masters brand.
