Share Investor: The Warehouse Group

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The 2011 full year profit result for the Warehouse Group Ltd [WHS.NZX] has once again rekindled the obvious. That the company needs to makeover its stores, bring in some service and sell stuff that people actually like to buy at the price that is consistently cheaper than its competition.

We have discussed just this over many years on this blog 1, 2, 3, and the essence of my argument for a warehouse turnaround has always been that the company must sell branded goods at the best prices with all the other retail essentials wrapped around that: consistency of product availability, better quality goods, better service with staff more engaged with customers and advertising that promotes these things to the right people.

Their 2011 strategy to investors for a turnaround doesn't fill me with much confidence that management know where they are at now, let alone how they will get out of the rut they have been in for the last 5-6 years.

Enough about what I think though. Shareholders want to know how management are going turn the company and its failing red sheds performance around so lets see what newish CEO Mark Powell has to say. (read Q & A with previous WHS CEO Ian Morrice here)

Lets get down to brass tacks and ask him what and how practically he is going to do as CEO to turn the company around.

The Q & A was conducted via email & I want to thank Mark for agreeing to do this kind of format interview - he usually only does face to face.

The Q & A

Share Investor - The Warehouse has had a series of flat results over the last few years on stagnant revenue. Do you see an end to this anytime soon and if you do what steps are you taking as CEO to grow sales and profit in the future?

Mark Powell - The recent strategy presentation outlined our plans for the future. It recognises the fact that over the last few years we have not grown sales and profit and identifies five key strategic result areas to address this issue. First, a very clear view of our brand and what it stands for, we aim to be the ‘House of Bargains’ and the ‘Home of Essentials’ for all our customers and to have a very clear product, price and promotion strategy to differentiate us in the market. The recent changes in our advertising reflect this, and if you compare it to six months ago the changes are actually significant and obvious. Second, a very clear Way of Working, based on best practice in mass market retailing, which ensure a ‘Customer Led, Store Focused , People Centred’ culture impacting all aspects of our business . This change is dramatic and will radically improve how we execute strategy over the long run and respond to our customers needs. Third, is Category Growth and Margin Dollar improvement. Ultimately customers buy products and we will focus the buying teams on managing their categories in line with our product, price, promo framework and through our clear way of working. Fourth, we will improve the store experience for our customers, by ensuring great service and execution of retail basics. This has slipped over recent years as we’ve tried to save store wages, but probably gone too far, this has been addressed and we’ve simplified and focused our store teams on what is really important for the customer. Fifth and finally, we will be rejuvenating our store environment by investing in refitting our store base over the next few years, ensuring a modern contemporary shopping environment. There is insufficient space in this type of written reply to really unpack the depth of thinking and change at play, but it is significant and will radically improve the business. How quickly that translates into sales and profit is difficult to predict, but over the long run of this 3-5 year strategy it will. However, in the short term it will lead to lower profits in 2012 as we build a long term sustainable platform for sales and profit growth.

SI - A successful strategy for a company turnaround has been a long time coming. Why do you think previous efforts have failed and explain why you think this time will be different?

MP - The company has tried a number of major initiatives in the past that have not delivered the benefits hoped for, such as Australia and Grocery, which also took a great deal of management attention and time. Also management had to deal with the distraction of corporate activity and commerce commission enquiry. Perhaps the key difference now is the scope and depth of the strategy in how it addresses the fundamental issues of the core general merchandise business , and the fact that management is totally focused on this and nothing else.

SI - Basically, could you explain your turnaround strategy to Share Investor readers and Warehouse shareholders?

MP - This is really answered above in the first question, however, the key to the strategy is focus on the customer and the basics of retailing – this will deliver the turnaround required.

SI - Is the "Red Sheds" strategy based on your success at Warehouse Stationery and if it is do you expect similar results?

MP - Yes it is, but it is also based on my experiences with Wal-Mart in Canada and Tesco and Iceland in the UK. In terms of results, I do expect similar results in the long run, although it must be recognised that Warehouse Stationery had fallen back a lot further and therefore the rebound was much more dramatic. The Warehouse has not suffered such a dramatic decline and therefore progress will be more gradual.

SI - The following quote, "TWL a mass-market retailer well represented in all customer segments other than extremes." (Page 20 of 2011 report) from the 2011 Full Year Result and Strategy Report doesn't resonate with me, my fellow shareholders and other Warehouse customers I talk to. Do you really believe that the company is "well represented" in all customer segments given that your competition has progressively taken away almost 25% of your market share over the last 5-6 years?

MP - Yes I do believe we are ‘well represented’ in that all socio-economic and demographic groupings do shop at the Warehouse, but I also recognise that this is a relative term. We are relatively underweight in some groups while still extremely strong in others. In comparison to similar discount mass market retailers in other markets around the world in most categories we have a relatively large absolute market share in most customer groups. My point in making this statement was to outline the strong base we have, however, this is not to deny the fact that our share has declined and that many customers only shop for limited categories and occasions. Our challenge is to reverse the decline and build on this still strong base.

SI - Like most people, I like to buy brands and I think the availability of name brands at your stores is one of the big keys to a successful turnaround. Why don't you carry a wide range of brands seen in your competitors stores; Nike, Sony LCD & Plasma TVs, Levis, Speedo, Bendon, to name just a few, and sell them at competitive prices. Will you stock these household brands and others in the future?

MP - The Warehouse does stock a huge range of well known brands such as Apple, HP, Mambo and many others, and also has a great range of private house brand labels. However, we would like to add more and are actively pursuing this. Brands are however a two edged sword, and we will seek to maintain a good mix of brands and private labels, giving our customers the choice they desire.

SI - Briscoe Group Ltd [BGR.NZX] has managed to grow sales and profit well over the last 12 months in the middle of lacklustre consumer confidence and a poorly functioning economy. Where have they succeeded while the Warehouse has failed?

MP - Sorry, but I’m not really going to comment on specific competitors as this can reveal our commercial thinking and also can be misinterpreted as criticism of them. I would say though that Briscoes are a specialist retailer, rather than a broad based mass merchant, and as such a more appropriate comparison of performance over the last few years would be with the performance of Warehouse Stationery.

Reader Question - Conventional wisdom suggests that the Warehouse grows sales/market share during harder economic times. However that does not appear to have occurred during the present recession, the worst in living memory. This has been reflected in a share price that has been flat for the last two years apart from one short-term spike. Does your analysis support this contention and if so, is the company confident that appropriate measures are in place to improve prospects in the medium term?

MP - It is a known fact that we haven’t grown overall sales/market share over the last few years, although there are significant variations by product category. There have been many variables at play over the last few years that have contributed to the Warehouse not gaining during the recession. In comparison to many retailers it could be argued The Warehouse has weathered it well, but also as CEO I must run a very critical eye over our performance. I am confident that we fully understand the root causes and that our strategy addresses them over the long run.

Reader Question - Where do you see the weak points of WHS that need an overhaul and where do you think WHS is operating really well right now?"

MP - Please refer to the strategy answer in the first question. This aims to address our weaknesses and to build on our base strengths.

SI - The spending of close to half a billion dollars over the next 4 - 5 years is alot of money just to get more punters in the door. How certain are you that the spending this large sum of money will do the business and what sort of return do you expect from this investment and how long do you think it will take to realise an acceptable return on that investment?

MP - Business involves risk, and the strategy has risks associated, however we have prudently assessed those risks versus return and we aim to maintain an ongoing return on funds employed in the current region over the long run.

SI - How will the strategy be funded?

MP - Through existing capital arrangements and normal property development disposals. For example we are developing a retail park in Silverdale which once completed we will aim to sell as a property investment.

SI - I am often disappointed by the levels of service offered to myself, my friends and associates and think sometimes it is so low because New Zealand consumers have low expectations and don't complain. How well do you think your staff represent the company in terms of service levels to customers so customers remain loyal and keep coming back for more over the long term and how will you change the low morale and lack of enthusiasm of far too many WHS staff.

MP - We have already invested in increasing the number of Team Members by 250-300 to ensure product is available and priced and to be available to help serve customers. We have also thoroughly overhauled in store routines, simplifying them, reducing bureaucracy and increasing focus on those key drivers of sales. In addition we have rolled out customer service training. All this has already resulted in a dramatic improvement in the store experience and team member morale.

SI - The Warehouse used to been recognised as the place to go first to get the best price for just about anything. How has your competition been able to now meet or beat your price offerings and how will your turnaround strategy rectify this problem?

MP - Price Competition in New Zealand is intense and don’t see that abating, that’s part of retail and we have to focus on creating a business that is strong enough to respond to such an environment. That is what our strategy is aimed at doing.

SI - Will the turnaround strategy involve concentrating somewhat on improving all-important margins which have slipped in recent years and how will you do that given the dire economic outlook?

MP - I’m not sure if you are referring to EBIT margins or Gross Profit margins in this question. The aim is to improve sales and to grow gross profit dollars over the long run at a greater rate than cost inflation.

SI - When do expect to see the first evidence that your turnaround plans are working?

MP - In each of the strategic result areas outlined above results will vary in how soon they can e expected. Some changes such as in the marketing and store execution have already shown a great deal of improvement, other changes such as category developments and store refits have longer lead times, hence my references to improvement “over the long run”. Hence, as indicated in the strategy presentations given, we expect a decline in underlying NPAT in 2012 and aim to grow NPAT over the long run after that.

SI - What are your medium to long-term growth plans (5-10 years) in terms of company size and revenue growth?

MP - We need to get the company back to incremental same store sales growth of 2 to 3% per year plus the incremental store space growth of about 10% over five years indicated in the strategy presentations.

The Q & A questions were compiled some months ago and I had one further question to add to the above regarding the controversy surrounding director fee increases indicated last week at their 2011 annual meeting.

Here is the question:

SI - How can the company justify big increases in directors fees given lower profits and tough times for the company along with a poor economic outlook?

MP – This is more a question for the board. However as indicated at the AGM last Friday, and passed by the vast majority of shareholders, the increases asked for were conservative and our absolute level of directors fees are nor excessive by any measure. The Shareholders Association spoke in support and the rises are necessary for ensuring we can maintain the required board standard going forward.

Disc: I own WHS shares in the Share Investor Portfolio

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