Red Shed on the upswing

''Good progress, but work needed to re-engage ‘the doubters' - those who stopped shopping with us through years of decline."

This was the blunt message The Warehouse delivered to its shareholders on one particular slide at its AGM last November.

While admirably honest, it was the sort of comment a company only makes once it is confident it is on the upswing again.

The Warehouse is. But its revival strategy has been a long time coming, has required heavy investment, and has yet to show a pay off for shareholders.

The long malaise at The Warehouse was caused by two big strategic blunders: its disastrous foray into Australian retailing 2000-05 and inadequate investment at home while the company rebuilt its confidence and finances.

For six years post-Australia, the company's strategy was misguided, said Mark Powell, The Warehouse's chief executive since mid-2011. It was based on the "flawed belief we could be a yield stock without investing in growth."

The stagnation was plain to see. Revenue and earnings before interest and tax were lower in the company's 2011 financial year than they were in 2005.

At that low-point three years ago, The Warehouse embarked on a recovery and growth strategy focused on four priorities: Keep the Red core strong (The Warehouse stores); Grow non-Red to be as large as Red; Be the leading multichannel retailer in New Zealand (via a big investment in online retailing); and leveraging the group's core skills and scale.

The recovery began in fiscal 2012 and took a big leap in fiscal 2013, thanks to the acquisition of the Noel Leeming electronics and appliance stores in mid-year. For the full year, The Warehouse sales were up 29 per cent at $2.24 billion and operating profit rose 15 per cent to $111 million.

The recently released half-year results showed further progress. Same store sales were up 4.1 per cent at the Red Sheds, 4.9 per cent at Warehouse Stationery and 9.3 per cent at Noel Leeming. And revenues growth at Torpedo7, the sports equipment seller which is the company's main online investment, were up more than 30 per cent.

The interim results were also notable because the company announced a fifth strategic priority - to become a leading NZ retail financial services company.

While it has long offered its customers credit cards, finance and some insurance through joint ventures and third-parties such as Westpac and General Electric Finance, this new goal will take a major investment to bring many of the services in-house and develop others. To help finance that, it raised $115m from shareholders last week.

Buying Noel Leeming made it possible for The Warehouse to establish this fifth leg of its growth strategy, Powell said. The chain brought a range of more expensive goods and wealthier consumers into The Warehouse group. This gives it much wider scope to tailor financial services to different types of customers.

To give itself core people and systems for its own financial services business, The Warehouse is paying $3m for the NZ operations of Diners Club.

Powell acknowledged Diners Club is a distant also-ran among global credit cards but The Warehouse will offer it as its premium card to the sort of customers who buy expensive flat screen TVs from Noel Leeming and $10,000 bicycles from Torpedo7. In contrast, the Red Shed customers will have credit cards that generate discounts and rewards for them.

The Warehouse will take its time to unwind its existing joint ventures and third party arrangements, although it will keep them in insurance. It won't introduce new financial products until the first half of fiscal 2015.

Its financial receivables are currently $400m and it could take five years to grow them to $600m, Powell said. He expects the new operation will lose up to $3m in 2014 and possibly a similar sum in 2015, depending on the pace of roll-out of new products. Financial services are expected to contribute to earnings in 2016.

With 1.3m customers a week, The Warehouse believes it has a big potential market for financial services. "But we are also humble enough to realise how small we are compared with the banks," Powell said.

"We don't foresee being a bank or a deposit taker," Powell added. But when pressed on comparisons with Tesco, a former employer of his, which does offer banking, Powell replied: "I never say never."

It's always risky drawing comparisons between New Zealand and other countries. Consumer trends can be similar but it takes a lot of work to translate them in this small market.

From its origins in 1982 as a one-shop seller of surplus stock to the giant it is today, The Warehouse has shown it is adept at learning lessons from the likes of Walmart and Target in the US and Tesco in the UK and making them work at a far small scale.

The company also deserves credit for taking big strategic initiatives, even if some of them such as retailing in Australia and food retailing in New Zealand, end up as costly failures.

In its current five-focus strategy, three elements are meant to be the big growth drivers: non-Red Shed in-store sales, particularly in Noel Leeming; online sales; and financial services.

The trio, though, need to work together to maximise their potential. This won't be easy. Online is evolving fast, often thanks to new, disruptive players and financial services are slow-moving and dominated by incumbents.

Potentially, The Warehouse could succeed. It has made a number of astute acquisitions such as Noel Leeming and Torpedo7 and other assets in online retaining. It is also starting to generate some synergy between them.

But its investment in growth has yet to pay off. Its operating margin fell from 7.3 per cent in fiscal 2009 to 5 per cent in fiscal 2013, while its debt ballooned from $47m to $217m over the same five years.

To help it fund its ambitions, the company announced at its recent interim result it was cutting its dividend payout ratio from 90 per cent to a range of 75-85 per cent. It bravely said this signalled The Warehouse was becoming something of a growth rather than a yield stock. It's a refreshing change to see a large NZ corporate go for growth. If The Warehouse pulls it off, it will be another notable chapter in its history.

Sunday Star Times