What Coles has cost Wesfarmers

Buying Coles in 2007 basically meant Wesfarmers couldn’t do anything else for a decade. No wonder it’s getting rid of it.

Wesfarmers CEO at a Coles supermarket.

Wesfarmers’ acquisition of Coles in 2007, now to be undone, is one of the great illustrations of opportunity cost in history. There should be an MBA unit built around it.

It’s true that Wesfarmers’ share price has outperformed the ASX 200 since then (+21 per cent versus -3 per cent) and it’s also true that, at $19 billion or so, Coles on its own now appears to be worth what Wesfarmers paid for Coles plus Target, Kmart and Officeworks ($19.3 billion).

But that’s not saying much. I’d say Target and Kmart pretty much cancel each other out (Kmart’s a success, Target a disaster), and what’s Officeworks worth? Wesfarmers tried to float it last year for $1.5 billion and that failed: so, $1 billion?

Let’s be generous and say the combination of Target and Kmart is not zero but $1 billion. That means the Coles investment has produced a total capital return in ten years of 10 per cent, or 1 per cent per annum.

But that’s not the worst of it. In 2006, Wesfarmers’ return on equity was 27.7 per cent. In 2017 it was 12.4 per cent. Apart from Coles it was 26.6 per cent; the retailer’s 9.7 per cent ROE dragged the total down, as it has done every year since 2008.

Before 2007, Wesfarmers prided itself on its consistent ROE of 20 per cent plus. After 2007, not so much: return on equity suddenly wasn’t that important any more. Fair enough — ideas change, as the CEO over those 10 years, Richard Goyder, has always argued.

But that’s not the worst of it. In 2006 Wesfarmers had roughly the same market cap as Amazon, about $40 billion. Now Amazon is worth A$947 billion; Wesfarmers, $50 billion.

The year 2006 was when Amazon started a business called Amazon Web Services, as an experiment, renting out computing power to other companies that needed it.

In April 2015 Amazon disclosed the profitability of AWS for the first time: it then represented two-thirds of the company’s total profits; last year it was more than 100 per cent.

That’s what is meant by opportunity cost. Buying Coles in 2007 for $19.3 billion has basically meant that Wesfarmers couldn’t do anything else for a decade. No wonder getting rid of it is new CEO Rob Scott’s first act.

Not that Rich Goyder’s Wesfarmers could possibly have produced the 40 per cent per annum compound capital growth that Jeff Bezos has done at Amazon since 2007, but what about CSL’s 17 per cent p.a.?

That was Wesfarmers’ capital growth in the decade before the Coles acquisition — 17 per cent p.a. compound. In the decade after it: 1.8 per cent.

Before 2007, Wesfarmers was a true conglomerate that bought businesses and applied its unique brand of capital discipline and management culture forged by Trevor Eastwood and Michael Chaney.

Those things continued under Richard Goyder, who is rightly regarded as one of the country’s finest executives, it’s just that they were applied to the wrong business.

The turnaround at Coles under the first CEO that Goyder appointed, Ian McLeod, was remarkable, and put Woolworths under such pressure that it became rattled and made the terrible mistake of throwing $3 billion at a hardware venture that was poorly executed and a bad idea to begin with.

But then Aldi launched in Australia in 2013 and transformed supermarket margins. Then came Amazon and soon Amazon Fresh and then the German hypermarket group Kaufman.

Could all this competition have been predicted? Of course. Ten years before Wesfarmers bought Coles, discount stores had close to 30 per cent of the Australian grocery market, until they were either bought by Coles and Woolies or went bust.

It was only a matter of time before the duopoly was challenged again. That’s being done by challengers that can’t be bought and definitely aren’t going broke.

* Alan Kohler is Publisher of The Constant Investor