tag:theconversation.com,2011:/fr/topics/earnings-season-2016-25256/articlesearnings season 2016 – The Conversation2016-02-26T00:43:05Ztag:theconversation.com,2011:article/553852016-02-26T00:43:05Z2016-02-26T00:43:05ZWoolworths counts the cost of Masters blunder, with food business under fire<p>Woolworths’ long-suffering shareholders may well be asking the newly appointed CEO, insider <a href="http://www.businessinsider.com.au/the-new-ceo-of-woolworths-is-insider-brad-banducci-2016-2">Brad Banducci</a>, if today marks the <a href="http://www.asx.com.au/asxpdf/20160226/pdf/435czmgwcn2stm.pdf">nadir of the company’s woes</a>. The answer, sadly, is probably not.</p>
<p>The Masters disaster has been <a href="https://theconversation.com/masters-was-spoiled-from-the-start-now-woolworths-must-go-back-to-basics-53282">well documented</a> and today Woolworths has tried to quantify the cost of this massive blunder at A$3.25 billion. The real problem, however, lies in the damage done to the rest of the business by this massive strategic and financial distraction, but also in the very real changes in the market for groceries, where Woolworths has traditionally made its profits. On every front, the news continues to be bad.</p>
<p>Stripping out the losses from the Masters joint venture attributable to Woolworths shareholders, every relevant metric today reported by Woolworths is pointing down. Food and liquor sales growth are behind general price inflation – thus declining in real terms. More importantly, margins are down significantly in this key element of the business such that EBIT in food, liquor and petrol is down a whopping 31.7%.</p>
<p>Curiously, Woolworths choose to combine its group EBIT for food, liquor and petrol (down by about A$600 million), while separating the sales figures (up by A$147 million and down by A$787 million). The management correctly noted that declining sales in petrol can be partly explained by lower petrol prices, and changes in the Caltex alliance, but a real question remains regarding just how profitable the individual businesses of petrol and food and liquor retailing actually are. The decline of comparable (like for like) petrol sales volumes of 2% raises serious questions about Woolworths’ growth strategies and future profitability in petrol.</p>
<p>It’s the <a href="http://www.rba.gov.au/publications/bulletin/2012/jun/pdf/bu-0612-2.pdf">margins and costs of doing business</a> reported today in the main business of groceries that should be of real concern to shareholders. Basically, margins report the difference between sales and the costs of goods sold while costs of doing business reflect staffing, rent, administration and most else. Both are moving strongly in the wrong way.</p>
<p>Put simply, for every A$100 trolley of groceries (and petrol) Woolworths sold in the equivalent prior period in 2014, the goods cost it A$74.54. This most recent period those goods cost it A$75.09. It cost Woolworths A$18.03 to sell those goods previously – most recently it cost the company A$19.70. Taken together then, for that A$100 trolley of goods, it made a profit of A$7.43 in the last half of 2014, while a year later it <a href="http://www.asx.com.au/asxpdf/20160226/pdf/435cz6mrp9yhpk.pdf">made only A$5.21</a>.</p>
<h2>Competition crunch</h2>
<p>Returning to the question asked at the head of this article – are better times ahead? The answer is almost certainly not. A key driver of declining margins has been Aldi, a firm that is accelerating its rollout. Aldi has recently opened in <a href="https://www.aldi.com.au/en/shopping-at-aldi/sa-now-open-wa-coming-soon/sa-and-wa-store-locations/">South Australia, with Western Australia next</a>.</p>
<p>Aldi’s success may well spur other global retailers to try their luck in Australia – in Europe firms like <a href="http://www.news.com.au/finance/business/retail/could-this-be-the-aldi-killer-german-discount-chain-lidl-prepares-to-open-in-australia/news-story/36ff46c01b6ab4d75ba240002f325eca">Lidl</a> and Carrefour have similar global sourcing and operational capabilities that could readily extend to new Australian operations.</p>
<p>Woolworths’ response to the changing market conditions has been less than impressive, albeit understandable when you consider its history. Once a comfortable member of one of the world’s most cosseted grocery duopolies, Woolworths developed large format stores that had vast ranges of goods that it sold at fat margins. It was a high cost and high margin model that left frustrated Australian consumers paying some of the highest grocery prices anywhere. Changing the Woolworths way of doing business is no small task as it is so entwined in the assets, business relationships and technology it has built over many decades.</p><img src="https://counter.theconversation.com/content/55385/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John Rice is affiliated with the ALP and NTEU.</span></em></p><p class="fine-print"><em><span>Nigel Martin does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Shareholders should be worried about how much it’s costing Woolworths to run its business.John Rice, Professor of Management, University of New EnglandNigel Martin, Lecturer, College of Business and Economics, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/551462016-02-24T03:50:45Z2016-02-24T03:50:45ZDomain versus REA shows it’s time Fairfax went all in on digital<figure><img src="https://images.theconversation.com/files/112670/original/image-20160224-16436-1j2q57k.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Domain and REA are going head to head, but what if one reinvented the game?</span> <span class="attribution"><span class="source">Image sourced from Shutterstock.com</span></span></figcaption></figure><p>When Australian media company Fairfax reported its <a href="http://www.fairfaxmedia.com.au/pressroom/au---nz-press-room/au---nz-press-room/investor-briefing-details-for-fairfax-media-fy16-half-year-results-announcement">results</a> late last week, the improved performance of its online real estate business, domain.com, appeared to violate a widely held <a href="https://theconversation.com/why-theres-no-pepsi-in-cyberspace-19902">“law” of the digital economy</a> - that digital creates a winner which takes all markets.</p>
<p>After a number of years trailing behind News Corp Australia owned realestate.com.au (REA), domain.com appears to have narrowed the gap with its major rival and its aggressive strategy of growing its user base is translating into improved revenue. Closer examination however suggests this result might just be a temporary pause in a much more profound transformation taking place for digital in the residential real estate industry. One that is likely to see the emergence of a new set of players.</p>
<h2>Can there only be one?</h2>
<p>It’s become commonplace for observers of the digital economy to claim that digital creates “winner takes all” markets. The classic example is Google’s dominance in the search market. Estimates suggest Google accounts for more than 75% of search, and almost 90% of organic search traffic, with its major rivals, Microsoft’s Bing and Yahoo struggling to get out of single digits. This effectively places Google in a monopoly position and allows it to create enormous revenues through products like paid search and adwords. </p>
<p>Using this example it would be tempting to conclude that REA, having established a healthy lead over domain.com in terms of unique visits and exclusive listings, would pull away from its Fairfax rival and come to dominate the Australian residential real estate market. </p>
<p>Instead, Domain is closing the gap on its rival. In part this reflects domain.com’s aggressive strategy of driving traffic to its site, one that ironically parallels the approach taken by News-owned carsguide.com.au in its battle with caresales.com.au. It also suggests that domain.com’s focus on the user experience is beginning to pay off. </p>
<p>Domain’s inhouse development expertise has given it the ability to more rapidly add new features that enhance the user experience, such as its mapping functionality.*</p>
<p>While there are important lessons here for business about not giving up and continuing to focus on the customer, viewed in longer perspective, it’s hard not to conclude that domain.com’s improved performance might just be a temporary reversal of a much more significant transformation taking place in the domestic real estate market. </p>
<p>There can hardly be a market more ripe for disruption than residential real estate. Australian residential housing stock is worth an estimated A$5 trillion and the market is riddled with the type of information asymmetries and inefficiencies that emerging technologies are ideally suited to address. While REA and domain.com have displaced the listing of properties in newspapers, they have hardly transformed the industry. Rather they seem to offer a digital version of traditional real estate listings with a few additional bells and whistles. Both are underpinned by largely similar revenue models. </p>
<h2>Reinventing the market</h2>
<p>It’s worth remembering that before Google, search was dominated by Yahoo, Alta Vista and Netscape. Google transformed search by developing an algorithm based on relevancy that improved the results users gained from searching the web and by rethinking how it monetised search. Rather than try to keep users on its page and bombarding them with advertising, Google directed users away from its page and towards the pages they were looking for. It’s reasonable to expect that the residential real estate market is likely to undergo a similar transformation over the next few years. </p>
<p>It’s interesting to compare the very traditional approach of realestate.com and domain.com with the radically different business models that are emerging in startups looking to disrupt the residential real estate market. </p>
<p>A good example is openagent.com.au, an Australian-based startup founded by two young women who started their careers in consulting. Recognising the highly localised nature of real estate markets and the importance of agents, openagent.com.au takes advantage of publicly available data sets and user reviews to provide sellers and buyers with reviews and metrics on agents in their local areas. Rather than attempt to charge users for accessing the information, or agents for better listings, openagent’s revenue comes from the referral fees payable by agents who get listings as a result of the reviews on the site. This is a much purer digital play than either REA or domain.com. By providing them access to data in a usable form openagent.com.au seeks to empower buyers and sellers and increase transparency in this very opaque market.</p>
<p>Perhaps the most important lesson Fairfax could draw from the performance of domain.com is not that the winner takes all logic of digital markets is reversible, but that they should have the courage of their convictions and go all in on digital, in the residential real estate market. Rather than just try to close the gap on REA it should be seeking to build a business that will do away with the need for businesses like domain.com at all. It might just find that if the solution it develops is good enough, the law of winner takes all will reassert itself.</p>
<p>*<em>This article was corrected after publication to remove a claim that REA outsources all of its development work.</em></p><img src="https://counter.theconversation.com/content/55146/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nick Wailes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Fairfax’s Domain is closing the gap on its rival REA, in a game where there’s usually one winner.Nick Wailes, Associate Dean Digital and Innovation, UNSW Business School, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/552272016-02-24T00:42:03Z2016-02-24T00:42:03ZSay what you like about BHP, it didn’t squander the boom<p>During the commodity price boom from 2004-2011 BHP Billiton’s board raised the firm’s dividend to an unsustainable level. Now, in the commodity bust, the board has been forced to cut it by 75%.</p>
<p>The board has been heavily criticised for its conduct of dividend policy. Critics have focused mainly on the type of dividend policy and timing of dividend changes. But that misses the big picture in a cycle of boom and bust.</p>
<p>The performance of BHP’s board and its management should be measured by the amount of shareholder value created, after controlling for factors beyond their control. Was the windfall of cash generated in the mining boom either invested wisely or paid out to shareholders, or was it wasted on bad investment and value-destroying acquisitions? The latter has been the historical normal for global resource companies through resource boom and bust cycles.</p>
<h2>The windfall</h2>
<p>BHP’s operating cash flows grew from US$5 billion in 2004 to US$30 billion in 2011. BHP’s board responded by increasing dividends nearly sixfold, from 9.5 to 55 US cents per share in just the seven years from 2004 to 2011 (29% annual growth). In the following four years dividends grew only another 7 cents per share (3% annual growth).</p>
<p>After 2011 the price of all of BHP’s commodities fell – first slowly and then quickly. Cash flow shrank to the point that BHP’s board was forced to choose between its “progressive” dividend policy and its “A” credit rating. The credit rating prevailed.</p>
<p>Before being too critical of the BHP board for not implementing its own dividend policy, we should consider the whole picture of how BHP used its cash flows in the 2004-2011 period.</p>
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<p>What does this table above tell us about BHP’s management of its cash flows?</p>
<p>Debt reduction, share buybacks, dividends: US$25 billion of the windfall of cash was used for debt reduction. Another US$44 billion was returned to shareholders in the form of share buybacks (US$22 billion) and dividends (US$22 billion) – a total of US$69 billion. Thank goodness for that.</p>
<p>Acquisitions: BHP spent “only” US$11 billion of its cash flows on acquisitions in this period: US$6 billion on Western Mining in 2005 and US$5 billion on the Fayetteville gas assets. Another US$15 billion was spent on the Petrohawk gas assets only days after the end of this period. </p>
<p>Unfortunately, the first half earnings announcement included a write-down of the US gas assets by US$7.2 billion. But criticism of the purchase of those assets relies mainly on the advantage of hindsight.</p>
<p>Nonetheless, it is by good luck rather than good management that more was not wasted on expensive acquisitions – especially in BHP’s failed bid for Rio Tinto when then CEO Marius Kloppers offered to pay at least US$20 billion over the odds for Rio. This assessment does not rely on hindsight. It is based on the increase in the BHP share price and decline in Rio Tinto’s share price at the time the BHP bid was withdrawn.</p>
<p>Capital expenditure: BHP spent the largest part of its extra cash flow on expanding production. There is always a danger that firms that receive cash windfalls will waste the cash on low-return investment projects. For the most part BHP has not done that in this cycle – although the plans for the US$20 billion expansion of the harbour in Port Hedland were a very worrying sign.</p>
<p>After considering how BHP’s windfall of cash flow was used in the boom period of 2004-2011, is it right to criticise the BHP board for paying out a large amount of cash as dividends, even if that made dividends unsustainable?</p>
<h2>The verdict</h2>
<p>The board might have made greater use of buybacks, especially to buy back more shares in London where BHP shares traded at a large discount to the same share on the ASX. It might also have declared “special dividends”, but that would have signalled they did not believe the cash flows were permanent.</p>
<p>But those considerations about how cash should be paid out of the firm are not the first-order issue when an unanticipated surge of cash flows occurs. The total volume of cash paid out is what shareholders should focus on. BHP’s board should be applauded for raising dividends during the boom. That proved unsustainable, but so what?</p>
<p>Overall, BHP’s board has done a reasonably good job of not squandering the proceeds of the mining boom. The fact that its dividend policy proved unsustainable is simply not the main issue.</p><img src="https://counter.theconversation.com/content/55227/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sam Wylie does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>BHP’s board has navigated well through mining’s highs and lows and still passed the shareholder value test.Sam Wylie, Principal Fellow, Melbourne Business SchoolLicensed as Creative Commons – attribution, no derivatives.