Coles spin-off the shake-up Wesfarmers needed

By announcing a Coles spin-off, Wesfarmers’ Rob Scott clearly thinks he’s got all the value uplift he can from the retailer.

Prepared to make the big calls: Coles boss Rob Scott

Wesfarmers chief Rob Scott has moved quickly to put his stamp on the business, announcing it will shed its biggest capital consumer Coles and signalling a major shake-up of the company.

At a time when the market was questioning Wesfarmers’ conglomerate nature, the planned Coles demerger actually underlines its existence, but the big unknown is what Scott buys next.

The decision gives him more flexibility ahead of a looming decision on the future of its struggling Bunnings UK operation.

Wesfarmers’ stock price has been rangebound for four years and it needed a radical move to shake it out of the range.

Scott has delivered just that and with Bunnings now set to account for 50 per cent of earnings it should lift its market rating.

Bunnings is a growth business while Coles is a mature cash generator.

Wesfarmers trades at around 16.6 times forecast earnings on JP Morgan numbers, which is below the 18 times multiple on which industrial stocks are trading.

At around $41 a share it was also trading at around its break up value which tells you the market is not giving you any reward for your conglomerate structure.

They were the numbers which helped Scott pull the trigger.

The move signals his stated intention to radically shake up the Wesfarmers he inherited.

The $18 billion Coles acquisition in 2007 was Richard Goyder’s big deal to transform the company but Scott clearly thinks he has got all the value uplift he can from the retailer.

Metcash’s Steve Cain will lead the new business after being shown the door by former Coles boss John Fletcher in the months leading up to the Coles acquisition back in 2007.

Cain is a highly experienced retailer but comes to the business at a tough time, with Woolworths having all the momentum over Coles.

Coles accounts for one third of Wesfarmer’s earnings but also 60 per cent of its capital and this is an equation which Scott feels the company can no longer maintain.

The company will retain 20 per cent of Coles but the rest will be spun off to shareholders who will get a stock which Wesfarmers argues will be a top 30 company.

But it is also one under pressure, with Woolworths maintaining a momentum lead over Coles.

Wesfarmers’ move is a boon to Woolworths, because it takes its major competitor out of a financially strong conglomerate and now it has to fight for its own capital.

Last year Coles’ return on equity fell from 11.1 to nine per cent with a massive $16.5 billion in capital or over four times that of its higher returning stablemate, Bunnnings.

Bunnings in Australia is the clear star of the Wesfarmers portfolio.

Outgoing Coles boss John Durkan has spent 10 years at the business and played a key role in the turnaround of the company, and has been responsible for the value uplift it has created.

He clearly was unwilling to commit for another five years, which would be needed to lead the new company.

Cain wanted the top job over a decade ago and now he gets his chance.

Cain worked as Coles supermarket boss from 2003 to 2005 ahead of the Wesfarmers 2007 Wesfarmers Coles acquisition which also included Officeworks, the struggling Target and well performing Kmart operations.

Scott has taken a bold first step.

Now comes the big one — whether he will back the turnaround of the Bunnings UK business which potentially will cost the company $3 billion, including lease liabilities from the existing British Homebase stores.

On the basis of today’s move, Scott is clearly prepared to make the big calls.

Just where he takes the company long term with what he calls higher earnings businesses remains to be seen, but the conglomerate structure is alive and well.