In its pomp, Australia's Wesfarmers liked to think of itself as a sort of antipodean Berkshire Hathaway: buying undervalued, cash-producing businesses and letting skilled managers run them with clear targets to generate strong returns on invested capital.
So much for that. While Warren Buffett hardly ever bids farewell to a business, Wesfarmers on Friday unveiled plans to spin off its Coles supermarket chain in a move that would create a $20 billion company and reverse one of the country's biggest-ever takeover deals.
While Managing Director Rob Scott told reporters the move was part of his pitch for the top job he assumed in November, to outsiders it came out of the blue.
Wesfarmers isn't short of problems - there's the disastrous takeover of UK home improvement store Homebase; a Target supermarket chain that's been misfiring for the best part of a decade; and growing threats from German discount retailer Aldi and Amazon's arrival in Australia last year.
But Coles, despite recent struggles, still constitutes more than half of sales and assets, and more than a third of operating income.
That discrepancy is the problem, though. In a conglomerate whose operations include department stores, mines, chemicals, DIY and office supplies, along with stakes in a sawmill and an investment bank, Coles is just too big.
Of the $27 billion of capital employed in the 12 months through December, $16.5 billion, or about 61%, sat within Coles.
Pendulum Swing
That was all very well when Coles was a growth story. At the time Wesfarmers acquired the business for $15.2 billion in 2007, the supermarkets were failing in the face of a rampant Woolworths, the larger player in Australia's duopolistic grocery market.
Its new owners invested $8 billion on revamping the chain, and for a while, it seemed to be working: For 27 consecutive quarters, sales from Woolworths stores open at least 12 months failed to edge ahead of those at Coles.
Then the pendulum swung. The chief executive who'd presided over Woolworths' period in the wilderness resigned, and that company became the turnaround story. Sales growth at Coles, which didn't dip below 2.5% in the six-and-a-half years through June 2016, hasn't crept above that level since.
Coles' return on capital - never spectacular by the standards of a company whose Bunnings and Kmart chains consistently get results above 30% - dipped to 9% in the 12 months through December.
That's not far above Bloomberg's estimate of Wesfarmers' 8.2% weighted average cost of capital, meaning the business is teetering on the verge of economic losses.
It's hard to say what benefit shareholders will get from this deal.
For all Wesfarmers' recent woes, it's still valued at a premium to global peers, with an enterprise value about 9.2 times blended forward 12-month Ebitda estimates, compared to a median of 8.6 at food retailers in developed markets with at least $1 billion of sales.
Mixed Bag
What's left is a mixed bag, too. Bunnings has been a standout for years but is highly leveraged to an Australian housing market that's showing signs of cracking; its UK outpost, meanwhile, remains a disaster of epic proportions.
Kmart, the other engine of Wesfarmers' non-supermarkets business, goes from strength to strength but is at risk from an Amazon steamroller that looks on the verge of flattening Sears, the US chain from which Kmart used to license its branding. And while Wesfarmers' chemicals and mining businesses have been doing well of late, they tend to stumble when commodity prices weaken.
Wesfarmers' underlying problem is that it's not splitting off the businesses it needs to get rid of, but the one it can get rid of.
An attempt to set up an initial public offering of the Officeworks stationery group (another potential Amazon victim, and one whose returns have also been weak) ran aground last year.
Despite a A$1.26 billion ($980 million) writedown of mainly goodwill and brand names at Target and Homebase last month, those infected limbs aren't getting amputated yet either.
Splits of this sort work best when constituent companies tend to trade at wildly different valuations, but a quick sum-of-the-parts on Wesfarmers suggests there's only a sliver of extra value that's not already in the stock price.
With a wall rising between Coles and the remaining units, Scott is about to lose a huge slice of optionality in terms of allocating capital between the various businesses.
What remains will be far more cyclical than it was when Coles was in the mix. That seems a high price to pay in return for a marginal shift in value for shareholders.
News by Bloomberg, edited by ESM. Click subscribe to sign up to ESM: The European Supermarket Magazine.
