Analysts welcome Woolworths’ Masters exit

Analysts back move by Woolworths to jettison loss-making Masters, but warn wind-up costs will be significant.

The Masters Home Improvement store at Chullora. Picture: Ben Rushton/Getty Images.

Analysts have welcomed Woolworths’ decision to finally jettison its loss-making Masters hardware chain to focus more attention and capital on its flagship Australian supermarkets arm, saying the binning of Masters could remove a $275 million annual cash drag on the retailer as well as pump $200m extra into pre-tax earnings.

However, wind up costs associated with selling or closing down Masters could amount to more than $1 billion with writedowns set to flood the 2016 Woolworths (WOW) accounts with red ink as the group manoeuvres its complex exit from the Masters hardware disaster.

It comes as yesterday Woolworths finally succumbed to years of pressure to rid itself of Masters, agreeing to buy back one-third of the business from joint venture partner Lowe’s — for a sum as yet to be negotiated — so it can move to 100 per cent ownership and prepare the hardware and home improvement business for sale or liquidation.

Deutsche Bank analyst Michael Simotas said the sale of Masters as a going concern is unlikely but his analysis suggests liquidation would generate a modest cash inflow.

“There is risk that Lowe’s gets more than its fair share because payment will be made before valuation is determined but Woolworths will benefit from the removal of around $275m annual cash drag,” he said.

Mr Simotas said using very conservative assumptions to reflect the expeditious exit process (i.e. 50 per cent recovery value on properties, 70 per cent retail markdowns), Deutsche Bank estimate a one-off cash inflow of $241m largely from liquidation of fixed assets and inventory.

In addition, EBIT will increase by roughly $200m annualised, and a cash drag previously associated with Home Improvement of around $275m will also be removed.

Deutsche Bank’s net profit estimates have increased by 8 to 9 per cent from fiscal 2017 on.

However, investors should also not lose focus on the greater challenge facing Woolworths, the improvement of shrinking earnings from its supermarkets division.

“While resolution of this issue (Masters) is positive, underperformance of the food and liquor business is a bigger problem. Industry feedback suggests Woolworths had a tough Christmas notwithstanding substantial price investment.’’

CLSA analyst David Thomas said valuing the put option Woolworths will buy from Lowe’s will not be simple with his initial best estimate of $450m being the halfway point between $0 and $887m.

“There is likely at least another $550m to $600m in further costs which … will take the total (Masters) wind up cost to around $1 billion,” CLSA said in a report to clients this morning.

Macquarie Wealth Management said in a note to clients that the disposal of Masters was “the right call.”

“We believe the Woolworths board has made the right decision in exiting Masters post the Lowes put option being exercised, rather than downsizing the network, enabling investment in supermarkets without raising equity.

“The key outcome for Woolworths is the elimination of around $250m of EBIT losses and the opportunity it creates to invest in supermarkets.”

However, the report warns investors that resuscitating profits at its supermarkets won’t be an easy fix just because Masters will be out of the way.

“In our view, execution of the funds invested into supermarkets will determine the value of exiting Masters. Simply having capital available to invest does not guarantee a successful turnaround but it does give Woolworths a greater chance.

“In our view, the announcement of a new CEO and the strategy implemented by the senior management team will be the most important driver of the turnaround.”

Credit Suisse analyst Grant Saligari said the Masters joint venture is estimated to be losing $245m at EBIT and around $170m at net profit in fiscal 2016, and post closure, Woolworths earnings per share from continuing operations would increment by around 7 per cent.

“We assume that Woolworths pays Lowe’s $180m and Woolworths receives a cash payment $550m on disposal of the (Masters) business.”