Aussie companies have a mixed record when venturing overseas. But in early 2016 Wesfarmers had a great history of building wealth for shareholders – an investment in the company’s shares in 2000 returned nearly 17% per year while the Australian market, including dividends, returned 8% a year over the same period.
The company had seldom disappointed shareholders, so when the Perth-based conglomerate announced its first ever foreign expansion into the UK’s home improvement market, investors gave it the benefit of the doubt.
Wesfarmers’ plan to slowly convert Homebase, a struggling UK home improvement retailer it acquired, into a copy of its successful Australian Bunnings business seemed credible. Bunnings was a proven concept and had grown to account for nearly 30% of the conglomerate’s $4.4bn of earnings before interest and tax.
But last month CEO Rob Scott confirmed what many feared – expanding overseas is anything but easy, especially for Australian companies.
Wesfarmers paid around $700m for Homebase. Since then its UK operations have lost $300m and attracted impairments of almost $1bn. How did a company with such a great track record get it so wrong? Overconfidence likely played a part.
Confusing skills with luck
After a long period of success we tend to attribute too much credit to ourselves when luck and the surrounding environment are likely important contributors. Investors often associate their long streak of rising investments in a bull market with their own stock picking prowess.
Similarly, in Wesfarmers’ case, directors may have overestimated their own role in Bunnings’ stunning success. While they undoubtedly worked hard, Bunnings’ strong competitive position and a buoyant property market are likely the key drivers of its performance.
In Australia Bunnings dominates the home improvement market. Its large store network, product range and advertising budget all act as powerful barriers to competition. Ask Woolworths and Lowe’s, not exactly untested retailers, how they enjoyed challenging Bunnings via their now defunct Masters joint venture.
So it’s somewhat ironic that Wesfarmers decided to go head to head with B&Q, the Bunnings equivalent in the UK. Even more so since B&Q was closing down stores at the time due to a weak market. And its 6% operating margin is nearly half of what Bunnings earns in Australia. Perhaps Wesfarmers directors saw that as a sign of opportunity for their superior skills, as opposed to an indicator of a much more competitive market.
Overconfidence can also lead us to oversimplify reality and underestimate risks. Wesfarmers’ directors were perhaps victims of this when thinking a ‘copy and paste’ strategy would work in the UK.
Australia is unique
Australia’s relatively small population and expansive geography mean a small number of firms with enough scale to justify staying in business dominate most industries. Look no further than the ‘Big Four’ banks, the supermarkets, or Bunnings itself.
The UK, on the other hand, sits on the opposite end of the spectrum. Its high population density and proximity to Europe make it a much more competitive market – one in which differentiation and innovation, and not scale alone, are prime drivers of success. For example, the internet plays a much more significant role in the home improvement market in the UK than it does Down Under.
And what works at home doesn’t necessarily work overseas. The UK market focuses a lot more on the professional segment. The UK’s colder weather and shorter days mean that the average Briton spends a lot less time in the backyard than the average Australian. Fancy barbeques and large outdoor furniture are tougher sells over there.
But judging from the recent $66m write-down relating to excess and unsuitable stock, this is something that Wesfarmers ignored or at least misjudged. Perhaps this could have been ameliorated if the company hadn’t fired the entire local Homebase executive team.
Bunnings’ UK operations are a small part of the overall Wesfarmers picture, so this debacle will not kill the company. It may even help it to refocus on its outstanding local businesses. But the lesson remains clear – investors should be extra sceptical of large Australian corporations venturing offshore. No matter how successful they have been on their home turf. More often than not, as Bunnings UK will likely confirm, such campaigns turn into messy retreats.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.