Wesfarmers – Coles Demerger

Wesfarmers announced their intention to demerge Coles, along with senior leadership changes, on 16 March 2018.

Wesfarmers will retain 15 per cent of Coles and 50 per cent of flybuys.

Eligible shareholders will receive one Coles share for every Wesfarmers share that they hold.

“Demerging Coles enhances Wesfarmers’ prospects of delivering satisfactory returns to shareholders by shifting our investment weighting and focus towards businesses with higher future earnings growth prospects,” Chairman Michael Chaney said.

In short, Coles does not meet Wesfarmers’ hurdle rate of return for capital employed (ROCE). A defensive, non-cyclical business, Coles on its own may justify a lower required ROCE.

Coles Demerger (November 2018)

Coles Group Limited (COL) commenced trading on the ASX on 21 November 2018, after the spin-off from Wesfarmers was approved by the Supreme Court of WA.

Trading is initially on a deferred settlement basis, with the demerger expected to be implemented on 28 November 2018.

  • Following the Demerger, Wesfarmers will continue to be one of Australia’s largest listed companies and private sector employers with around 105,000 employees.
  • Wesfarmers’ business operations will include Bunnings, Department Stores (K-mart & Target) and Officeworks retail divisions and the Industrials division with businesses in chemicals, energy and fertilisers, and industrial and safety products.
  • Wesfarmers will also have a number of other non-controlling interests, including a 15 per cent interest in Coles.
  • For the year ended 30 June 2018, Wesfarmers’ post Demerger pro forma revenue was $27.5 billion, pro forma EBIT from continuing operations was $2,734 million and pro forma EBIT from continuing operations and excluding significant items was $3,040 million.

Avoiding the hubris trap

Great example of how even the most professional management teams can fall into the hubris trap.

Michael Chaney describes to The Age how Wesfarmers burnt a billion dollars on the highly successful Bunnings hardware chain’s expansion into the UK market:

S&P 500

Bunnings Warehouse by Bidgee – Own work, CC BY-SA 3.0, Link

Chaney was the chairman that signed off and despite everything contends he had never seen a more thorough investment analysis than had been undertaken on Bunnings UK.

They had a base case set of projections and a downside case and it all looked very positive at the time according to Chaney.

But a couple of fundamental mistakes were made subsequently after acquisition of Homebase home improvement network of stores including the removal of 150 senior managers.

“One was moving out the senior management and replacing it with our Australian experts and the second was getting rid of a lot of the products and the franchises because they didn’t suit the Bunnings model,” says Chaney.

By way of example the Australian interlopers jettisoned Laura Ashley from the home decorator product line up – and British women voted with their purses.

It was the success of the Australian model and its management that blinded the higher ups inside Wesfarmers to the fact that these guys didn’t know better what the UK customers wanted. Wesfarmers got caught in the hubris trap.

Some years earlier hardware giant Lowes fell into a similar trap in the US. Number-crunchers at head office worked out that they could save a bundle by replacing senior salespeople with more junior, inexperienced staff. The knowledge base of experienced floor staff was decimated. Customer service and sales plummeted. As one manager described it: “we became find-it-yourself instead of do-it-yourself.” Fortunately Lowes were able to correct their mistake and should have learned a valuable lesson but it seems they did not.

Investors should always be on the lookout for the hubris trap. The more successful the company, the more vulnerable they are. Expanding operations away from the home country or state is often a high risk venture, where management may be blind to cultural differences, regulatory pitfalls and an array of new competitors. Expanding into new product lines or services that are outside management’s traditional core expertise may also present traps for the unwary.

Ask Woolworths (Australia) about their Masters hardware venture, Commonwealth Bank about their expansion into financial advice, NAB about their expansion into UK markets, Centro Properties (now Vicinity) and Westfield about their foray into US shopping centers,….. I could go on. It’s a long list.