WES's Coles Ambitions

But it will come at a cost, besides the mooted $21 billion value in shares and cash.

(The merger won't be valued at that if consummated, as the sell-off in the stockmarket will mean the actual values will be lower.)

Wesfarmers said yesterday that it plans to spend up to $5 billion over the next five years, reshaping and transforming the stumbling retail giant.

Between $1 billion to $1.2 billion will be spent in each of the 2008-09 and 2009-10 years.

It's looking for annual cost cuts of at least $385 million. Based on 2008's expected net profit of around $780 million (Coles' own forecast), the cost-cuts would push earnings close to a billion a year by from 2010 onwards.

WES plans to create three new businesses to integrate Coles Group into its structure, but the Kmart discount chain looks like it will be unwanted, leaving open the possibility that it could be sold to groups like Myer (owned by TPG), Woolworths or another ambitious group.

WES said in a statement to the ASX, which accompanies news of lower 2008 earnings, that the three new business divisions will be: Food, Liquor and Convenience; Big Box retailing to include Wesfarmers' Bunnings hardware business and Coles' Officeworks; and Target.

Kmart unit will be operated as a separate division while it undertakes a review of various options for the business: there's the suggestion it couldbe sold off.

Woolies has been sniffing around looking for either Officeworks and/or Target, or parts of Kmart.

It may end up being a decision for the ACCC.

Wesfarmers says it expects the corporate overhead cuts of $385 million a year will be in place late in the 2008-09 financial year (or just under two years time).

This figure will include $100 million in savings already achieved under Coles' program announced almost a year ago.

WES said supply chain cost savings are projected to reach $540 million a year by 2013, including $90 million achieved to date.

This looks like the same programs that WOW has all but finished in re-organising its distribution and store delivery and ordering processes.

Wesfarmers managing director, Richard Goyder, said in the statement that Wesfarmers and its supply chain consultants had thoroughly reviewed the current cost savings program.

"The principal beneficiaries of the program, the Food, Liquor and Convenience division, will become responsible for the delivering of the benefits," he said.

He said in the short-term, the goal will be to reverse a decline in sales at Coles, including its supermarkets, and target comparable store sales growth of 3% to 3.5% by 2009-10.

Seeing WOW's comparable store growth is running at double that rate, and Coles rate is around 1% (at the half way mark), it's going to be a big ask, and a big part of boosting margins and profits.

Mr Goyder said that each 1% increase in comparable store sales growth a year "is estimated to generate an earnings before interest and tax benefit of about $150 million in year five, before new store rollouts".

The Kmart review will be based on three options - improving the trading performance of the existing businesses, converting some stores to other formats and a sale of part or all of the business.

"It is my strong preference to retain Kmart but all ways of maximising shareholder value need to be considered, including a combination of the three options identified," said Mr Goyder.

Mr Goyder also said Coles' Tooronga headquarters in Melbourne would be abandoned as the business conforms to Wesfarmers' streamlined corporate model.

"As is well known, Wesfarmers has a very small corporate office which provides specialist support to the business divisions," he said.

"Under our ownership, each of the current Coles businesses will be given the resources they need to operate most efficiently rather than having to rely on functions centralised at the Tooronga head office.

"I want the divisional back up to be moved as quickly as possible out of Tooronga and into the operations.

"We plan to exit that building as soon as is achievable, subject to the current lease arrangements.

"Our detailed assessment of all the Coles businesses shows they meet our key investment criterion in that they will deliver a positive net present value for Wesfarmers and will therefore create value for our shareholders. Target and Officeworks will be value accretive from the date of acquisition and we see substantial value creation in the food, liquor and convenience businesses in the medium term."

"Consistent with the existing Wesfarmers' divisions, these business groups will report to the Wesfarmers Managing Director who will chair the board of each new division.

"Our management philosophy is built around having a lean head office that provides only services that add value to the operating businesses and divisional offices that recognise the specific needs of each business. Each business is given the authority and responsibility to manage their operations," said Mr Goyder.

Wesfarmers has developed a tailored management strategy for the Food, Liquor and Convenience Division, which will include the addition of international retail expertise and strong incentives to drive management performance.

"John Gillam, who has very successfully run Bunnings since 2004, will be the managing director of the combined Bunnings/Officeworks businesses," said Mr Goyder.

"Commercial executives from Wesfarmers will join the leadership team of each of the new divisions and I will be appointing a senior Wesfarmers person to oversee the entire integration process.

"As previously advised, senior managers for the Coles businesses will be drawn from current Wesfarmers and Coles managers and we will bring in leading retail expertise from outside.

"A global search is underway to identify candidates. I expect to announce key appointments about the time of completion in November so that certainly the most senior executives are in place and ready to proceed when we complete."

Wesfarmers has set a goal of releasing more than $300 million in working capital over the next five years from the supply chain initiatives and a particular focus on a centrally managed range and auto-replenishment.

In yesterday's sell-off, Coles shares fell 40c to $13.37 after hitting a low of $12.95 and WES shares were pounded, falling to a low of $37.15 before steadying and finishing 41c lower at $39.09.

Wesfarmers expects to pay fully franked dividends in excess of $2.00 per share in FY2008 and FY2009 if the Coles transaction proceeds, subject to the availability of retained earnings and franking credits.

It said that represents "an estimated 73% increase in dividend income for Coles shareholders".

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Wesfarmers CEO, Richard Goyder, says the company's floundering coal division is not for sale, despite it taking the shine of the 2007 profit and directly leading to a 25% drop in earnings.

The company revealed the 2007 earnings and its Coles plans yesterday as it mounted a big campaign to convince the market that it could ruin its existing businesses and takeover Coles and revitalise the retail giant.

Wesfarmers said net profit in 2007 was $786.3 million compared to $1.05 billion earned in 2006.

CEO, Richard Goyder, said it had been a good year for the majority of Wesfarmers' divisions, particularly Bunnings, its hardware business, but lower coal prices took some of the shine off the full-year result.

"As we foreshadowed 12 months ago and confirmed at the time of our half-year result in February, the full-year profit is down on last year's record because of the drop in coal prices," he said.

He told a conference call yesterday that he was a 'bull' on coal.

Mr Goyder was upbeat about the coal division despite lower export prices expected to continue to have a negative impact for the first three quarters of the 2007/08 financial year.

"I'm a real bull on coal," Mr Goyder told a conference call.

"We think the business, through increased production and sales opportunities in all three mines, the work that the industry is doing in terms of clean coal technology and its cash generating capabilities, is an important part of the group."

Wesfarmers has an interest in three coal mines in Queensland, NSW and Western Australia.

He was confident about the Coles deal and the outlook for the company.

"Looking ahead, the directors expect that all existing divisions with the exception of coal will make increased contributions to the 2007/08 profit result," Mr Goyder said.

"The anticipated completion in November of the Coles transaction will clearly have a major effect on revenues and earnings."

Mr Goyder said lower coal prices would continue to have a negative impact for the first three quarters of the 2007/08 financial year, with current expectations for a lift in prices in the final quarter.

Wesfarmers said operating revenue rose 10.1% to $9.8 billion in 2007, from the $8.9 billion in 2006.

Bunnings saw sales rise 15.5% on a topline basis (around 10% on a same store cash basis) to $4.9 billion and trading earnings rose 16%.

Coal revenue dropped 13.1% to $1.1 billion for the year down and earnings before interest and tax from the division fell more than 40% to $338 million from the $577.8 million earned in 2006.

Wesfarmers' insurance, energy and industrial and safety divisions also performed well.

The company declared a fully-franked final dividend of $1.40 per share, taking the total dividend for the year to $2.25 per share.

In his conference call Mr Goyder left some room for the sale of any of the group's assets.

"A caveat we always put on those things, if we think it is in our shareholders interest, then we would always look at disposing of an asset in the group," he said.

In fact, it is hard to see the synergies between any of the existing businesses and Coles, except for Bunnings.

Earnings per share were $2.10, a fall of 10.7% on the $2.36 recorded in 2006, excluding the sale of the Australian Railroad Group.

"We have seen an outstanding year from the Bunnings Home Improvement division with a 16 per cent lift in trading earnings. When profit from property development realizations is included, Bunnings' contribution increased by more than 25 per cent and its performance is the highlight of the 2006/2007 result.

"Through its product offer, price competitiveness and service focus, Bunnings is established as one of Australia's leading retailers.

"While the Bunnings' model is obviously not totally transferable to all other retail operations, the culture that underpins this very successful business is extremely relevant when we look at what needs to be done at Coles.

"Our other four business divisions also contributed more than in 2005/06, boosted by the inclusion of part-year income streams from new acquisitions in insurance and energy.

The full-year result included profit before tax of $26.5 million on the sale of non-current assets, compared to $4.9 million last year. In addition, as announced in June, Bunnings sold 11 warehouse properties which, together with other Bunnings property development activity during the period, resulted in a $53.7 million pre-tax contribution.

There was also a $17.8 million adjustment of a provision for coal mine rehabilitation.

These were offset to some extent by the $33.4 million interest cost on borrowings to fund the Coles' share purchase and $14.2 million in insurance integration and other one-off expenses, as well as $17.9 million in demurrage costs ($6.7 million more than the previous year) because of rail and port infrastructure constraints affecting the coal division.

Operating revenue for the Bunnings home improvement division increased to $4.9 billion, 15.5% higher than last year's, with trading revenue increasing by 11.9% over the prior year. Earnings before interest and tax of $528.4 million were 25.7% higher.

This result included a net $53.7 million contribution from the sale of property developments in Australia and New Zealand during the year. Trading earnings before interest and tax (excluding property, WA Salvage and other non-trading items) were 16.1% higher than the previous year.

Cash sales growth for the year was 13.8%, with underlying store-on-store cash sales growth of 10.4%. Pleasing results were recorded in all states of Australia and in New Zealand, with growth being achieved across all merchandising categories.

Is Bunnings all there really is to WES so far as Coles is concerned? A good question and one WES management has not yet tackled.

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