Wesfarmers to spin off Coles

Australia’s Wesfarmers Ltd plans to spin off its supermarket chain Coles and list it on the country’s stock exchange, as fierce competition forces the retail giant to shed low-margin operations and focus on fastergrowing businesses.

Shares in the mining-to-home improvement conglomerate jumped as much as 7% yesterday after it announced the demerger of the country’s No. 2 supermarket chain that analysts say could be worth as much as A$20 billion (US$16 billion), creating a top 30 firm on the bourse.

The move comes more than a decade after Wesfarmers bought Coles, discount chains Kmart and Target, and the Officeworks business supplies chain for A$21 billion (US$16 billion) in what was then Australia’s biggest takeover.

In recent years, however, fierce competition has eroded Wesfarmers’ profit margins despite billions of dollars of investments. Foreign retailers such as Amazon.com Inc have also piled on the pressure at a time when Wesfarmers is locked in a price war with arch-rival Woolworths Group Ltd.

“The move to demerge Coles, rather than Bunnings, likely indicates the less than attractive outlook for the Australian supermarkets industry,” Morgan Stanley analyst Thomas Kierath said in a note, referring to Wesfarmers’ successful hardware business which overtook Coles as its top earner in the six-months to December.

If valued above $14 billion, it would be Australia’s biggest spin-off, eclipsing Westfield’s demerger of its Australia and New Zealand malls as Scentre Group in 2014.

“As a diversified conglomerate, there is an opportunity for us to deliver a superior return,” managing director Rob Scott told reporters.

“And that doesn’t mean the returns from Coles won’t be good returns, they just will be more moderate levels of return. That’s really about why we’re proposing to undertake this demerger.”

Private equity firms, led by Kohlberg Kravis Roberts, had eyed Coles back in 2006 and 2007, and the spin-off could attract suitors again.

“We would welcome any offers but it would need to be at a very attractive value for our shareholders for us to consider it,” Scott said on a conference call from Perth, where Wesfarmers is headquartered.

The Coles supermarkets and liquor business accounts for 61% of the group’s capital employed but generates only 34% of its earnings.

The move underscores a challenging business outlook in Australia’s supermarket sector where a fresh food price war between Woolworths and Coles are driving deflation, while sluggish wage growth stays consumer spending power even as rivals compete for shopping dollars.

Jitters about Amazon’s entry to the retail market prompted Wesfarmers to cancel an IPO for its office supplies division that could have raised as much as A$1.5 billion.

Wesfarmers last month reported a drop in first-half earnings partly due to lower contribution from Coles.

“The outlook for grocery retailing in particular looks clouded,” said Michael McCarthy, chief market strategist at brokerage CMC Markets.

“There are definitely real and present structural threats to the industry and growth-rates in the business have been in decline for a long time.”

Wesfarmers saw strong growth potential for the nation’s No. 2 supermarket chain when it took it over in 2007, at a time when it had been losing market share against Woolworths.

But the turnaround dragged on longer than expected as Coles needed to plough A$8 billion into overhauling its stores.

Adding to the hurdles, competition against Coles and Woolworths grew over the past decade with private German group Aldi expanding rapidly in Australia and US wholesaler Costco making inroads, while Wesfarmers made a disastrous attempt to expand Bunnings in Britain.

“Last year was a very challenging year in the supermarket space given that our major competitor rebased their earnings and invested a billion dollars,” Scott said, adding that the market has since stabilised somewhat.

Now was a good time to consider a spinoff compared to 12 to 18 months ago, he said.

Wesfarmers said Steven Cain would succeed John Durkan as managing director of Coles.

If the demerger is implemented, Wesfarmers shareholders will receive one share in Coles for every share in Wesfarmers, and the company plans to retain up to 20% interest in Coles.

The separation, subject to board, regulatory and shareholder approvals, is expected to be completed in fiscal 2019.