Target scandal could hit Wesfarmers’ core

Richard Goyder, Wesfarmers Managing Director and Terry Bowen, Wesfarmers Finance Director touring Target store at Cockburn Gateway Shopping Centre in Success, Perth.

The resignation of Stuart Machin from the Wesfarmers group on Friday underscores how seriously the conglomerate is taking allegations that profits within the Target business were inflated by artificial deals with suppliers.

Machin, the former boss of Target who had been shifted to Wesfarmers’ head office after Kmart’s Guy Russo was given responsibility for both the group’s discount department store brands, has said that he was unaware of the accounting issues but accepted his responsibility as the group’s managing director at the time.

The allegations, which Wesfarmers appears to have accepted, revolve around rebates from suppliers that are said to have inflated Target’s first-half earnings which, at an earnings before interest and tax level, were up 5.7 per cent from $70 million to $74m and gave the appearance that the multi-year restructuring of the brand under Machin was finally gaining traction.

The twist which has caused angst within Wesfarmers and led to Machin’s departure was that the suppliers who provided the rebates — which impacted the reported result by up to $15m — were said to have been promised Target would repay them via higher prices in the second half.

In the context of Wesfarmers, which had earnings before interest and tax of more than $2bn in the December half, the amounts involved are immaterial and would, in any case, wash out over the course of the financial year.

Nevertheless, Wesfarmers is taking the issue very seriously, as Machin’s resignation shows.

Apart from its distaste for the accounting trickery the allegations point to (Wesfarmers takes its reputation and standing as a blue-chip organisation and its corporate culture very seriously), the allegations, if proven, go to the heart of its own operating model.

Wesfarmers is a conglomerate that has a ‘loose/tight’ operating model. It devolves enormous operating autonomy to its business units while maintaining stringent financial controls and disciplines.

For the model to work and for the group’s head office to be comfortable with the latitude it gives the management of the businesses, it has to be confident in the integrity of the financial information they provide it.

If the businesses were to use accounting legerdemain to disguise or inflate their actual performance, it would undermine the core of the Wesfarmers’ model.

That’s probably why Wesfarmers’ has been rocked by an issue which, in financial terms, is immaterial. The Target affair will almost inevitably lead to the Wesfarmers’ head office taking steps to protect the reliability of the financial data generated by its businesses.

Chief executive Richard Goyder said on Friday that since concerns about Target’s accounting were raised, the group had acted promptly and launched a “comprehensive investigation”. The results of that investigation are expected imminently.

The apparent artificial boost to Target’s reported earnings in the first half came against the backdrop of impatience within Wesfarmers at the pace of progress in the Target turnaround, which was reflected in the decision to give Russo (who has transformed Kmart into a profit powerhouse) oversight of the business.

At a store level, Machin — a key member of the original Coles turnaround team — appears to have done a pretty good job of improving the brand’s offer but, if the impact of the rebates were stripped out, Target’s financial performance remains dismal at a time when the rest of Wesfarmers’ retail brands — Coles, Bunnings, Kmart and Officeworks — are firing.

Machin referred to his own regrets on Friday, saying that while he felt there had been enormous progress in reshaping a very troubled business, the financial results had been “frustratingly disappointing”.

The appointment of Russo to oversee the brand was almost inevitably going to lead to changes in strategy and senior personnel within Target. The accounting issues guarantee them.