Consumer

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Wesfarmers Managing Director Richard Goyder is no doubt hoping history will repeat itself in his 340 million pound ($489 million) bid for U.K. DIY store Homebase. He should be careful what he wishes for.

The deal is Wesfarmers' largest acquisition since it carried out Australia's biggest takeover with its A$17.7 billion ($12.3 billion) 2007 purchase of supermarket chain Coles. Like Coles, Homebase is the tired second-ranked player in a market where it's being comprehensively outgunned by the market leader (in Australia, that was Woolworths; in the U.K., it's Kingfisher's B&Q). That provides a turnaround opportunity, like the one that drove Coles' operating income to A$1.78 billion last year from A$475 million in 2008.

But unfortunately there's an example closer to home of how big home improvement plays can go badly wrong. Australia's Masters chain has sucked in at least A$3 billion of capital since it was established by joint owners Woolworths and Lowe's in 2011, and still racked up a A$246 million loss last year.

Flatlining
Performance of Wesfarmers against consumer stock indexes, rebased
Source: Bloomberg data
Note: Jan 13. 2013 = 100

There are significant differences between the two businesses, not least that Masters was a startup whereas Homebase is a long-established chain that's already been restructuring in response to challenging conditions. Still, the record of big-box retailers making overseas acquisitions isn't a good one, from Wal-Mart's attempt to crack the German market and Tesco's Fresh & Easy foray in the U.S., to Carrefour's string of misadventures in Asia.

The U.K. home improvement and garden market, which Wesfarmers sees as ``attractive and growing,'' is one in which Homebase is in the process of closing 80 stores and B&Q is shuttering another 60. Put Australia's Bunnings next to Homebase, and it doesn't look like it's the U.K. with the good growth story:

Standstill
Revenues at Bunnings have taken off while those at Homebase have stagnated
Source: Bloomberg data
Note: Figures have been rebased, FY 2006 = 100

Maybe a better margin performance makes up for Homebase's lackluster revenues? Er, no: 

Marginal Benefit
Homebase's operating profit margins have trailed Bunnings' for a decade
Source: Bloomberg data

There are other significant differences between the two markets. In the U.K., online shopping has had such a dramatic impact that Homebase's owner Home Retail Group blamed it for the decision to close all those stores. Bunnings, by contrast, is so untroubled by the online threat it doesn't allow customers to make purchases via its website.

Australia's mining boom and tight restrictions on work visas have also kept wages high for tradespeople, encouraging homeowners to carry out DIY work instead. Bunnings holds regular classes at its stores to teach shoppers how to install windows and garden decking and save money on ``tradies". In the U.K., the availability of cheaper labor from the European Union means growth is coming from the ``do-it-for-me" services sector. 

Why DIY Still Rules in Australia
Most home improvement workers command a bigger premium over the median wage, relative to the U.K.
Source: Australian Bureau of Statistics, Office of National Statistics

Homebase, on the sale block thanks to Home Retail's attempts to primp itself for a takeover by Sainsbury's, may at least have the virtue of being cheap. Or it may not: Wesfarmers' offer values the company at 17.2 times last year's operating income, which looks like a discount to the 18.4 times median multiple for 14 takeovers of building products retailers in the past five years, according to data compiled by Bloomberg. Exclude takeovers outside North America, Europe and developed Asian countries however, and the comparable multiple drops back to 10.9, suggesting Homebase is pricey.

A better way of valuing the business may be to consider its internal profit metrics. Goyder professes to be obsessed with return on capital, but based on its latest full-year figures, Homebase would struggle to keep up  with Wesfarmers' other divisions:

Back of the Class
Homebase doesn't measure up well next to Wesfarmers' existing divisions.
Source: Company reports
Note: Shows Return on Capital Employed for Wesfarmers divisions and Operating Return on Net Assets for Homebase

Why make an acquisition at all then? Wesfarmers, which often compares itself to Berkshire Hathaway and has businesses spanning supermarkets, department stores, chemicals and coal mining, not to mention stakes in an investment bank and a sawmill, may feel that some sort of transformative deal is overdue. While its shares have outstripped an index of consumer staples businesses in the S&P/ASX 200 -- thanks to the dismal performance of Woolworths, which makes up nearly half the benchmark's weighting -- they've trailed discretionary retailers, and traded sideways for several years.

Goyder has held fire on deals before, such as the canceled 2013 sale of Li Ka-shing's ParknShop chain. In this instance, that is an example from history worth heeding.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Homebase's operating return on net assets isn't quite the same as the return on capital employed by which Wesfarmers' divisions are measured, but that's not a point in its favor. Unless Wesfarmers manages to pick up Homebase with net cash on its balance sheet, capital in the business is going to be higher than the value of its net assets alone, so the comparison if anything probably flatters the U.K. chain.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net