Warehouse group turns up the volume

The Warehouse has picked up electronics chain Noel Leeming Group for $65 million. Claire Rogers reports on what will it mean for shareholders and shoppers.

Few retailers have been embraced by Kiwis like The Warehouse. In its heyday, 80 to 90 per cent of New Zealand households visited the red sheds at least once a year - a better strike rate than the Catholic Church in the Middle Ages, says Tim Morris, director of retail research company Coriolis Research.

But, like many religions, The Warehouse has found its congregation falling, suffering from under-investment, and declining market share and sales during the past decade.

It has embarked on a strategy to turn the tide, including refocusing its brand message, improving product range and quality, growing its online presence, and revamping stores.

Its $65 million purchase of Noel Leeming this week from private equity firm Gresham is another plank in that strategy.

Noel Leeming is a major player, with about 25 per cent market share in a struggling sector. But just how much The Warehouse and its shareholders will benefit is uncertain, commentators say.

For shoppers, the move will mean cheaper prices in some products and better value deals in electronics and appliances. Most noticeably perhaps, it will also mean the ability to buy better brands at The Warehouse - widely seen as the key reason for the acquisition.

Morris says brand quality has long been a weak link for The Warehouse, particularly in electronics and whiteware, and this deal gives it serious leverage with brands that may have resisted a red sheds presence.

"If Sony doesn't want to sell to The Warehouse then suddenly Noel Leeming doesn't order anything from Sony."

The deal also delivers property benefits, allowing The Warehouse to move retail brands such as Warehouse Stationery and Noel Leeming between sites.

The Warehouse Group chief executive Mark Powell has signalled potential for back-office and other savings in advertising, support services and sourcing, as well as opportunities to extend financial services and consumer technology support services throughout the group.

So far, so good.

The fly in the ointment, according to analysts, is the struggling sector Noel Leeming operates in.

Data from Statistics New Zealand shows prices for audio-visual equipment, including flat-screen televisions, fell by an average of 19 per cent annually in the three years to September.

Forsyth Barr head of research Andy Bowley says the sector is characterised by low margins, heavy price deflation and discount activity.

Noel Leeming's margin on earnings before interest and tax for the last financial year was just 1.7 per cent, compared with around 5 per cent for the blue and red sheds.

The timing of the deal is ironic, he says, happening just months after one of the red shed's largest shareholders, Woolworths, exited the category by selling the underperforming Dick Smith chain for just A$20m (NZ$25m) to a private equity firm.

Bowley questions the ability of The Warehouse to enhance performance significantly at Noel Leeming beyond "immediate cost synergies" and says its experience in specialty retailing through Warehouse Stationery has not been a total success story.

The blue sheds saw sales for the year ending July increase 2.6 per cent to $207m but operating profit fell 3 per cent to $8.9m.

Powell says Warehouse Stationery has turned around after a patchy history, reporting 13 quarters of same-store sales growth in a declining office products market.

Morningstar analyst Nachi Moghe is also uneasy about the electronics/whiteware sector.

He predicts Noel Leeming will contribute $3.6m of profit each year for the next three years, based on last year's results and factoring in the borrowing costs of the debt-funded purchase.

"You'll see sales growth but you won't see profit growth because margins will be under pressure," he said. "It's not the right category for the company. The $65 million could have been better spent on investing in their own stores and expanding into categories where there is growth."

The news is brighter for consumers.

Powell says shoppers will see cheaper prices for products where it makes sense, or better value in the form of bundled products, promotions and finance deals. But how much cheaper and how much more value is anyone's guess.

Bowley says The Warehouse may be able to negotiate better prices for a small group of products that are sold in more than one of its retail brands.

Moghe sees scope to lower sourcing costs in electronics by leveraging The Warehouse's distribution centre in China. But he says product choice may fall over time as the retailer ditches underperforming, lesser-known brands after the introduction of higher-end ones to the red sheds.

Shoppers expecting a price war to erupt may be disappointed - at least immediately - with rivals of Noel Leeming and The Warehouse expected to let the dust settle. Little change is expected at Noel Leeming, although Morris says it would make sense to carry out the same store improvements it has in the red and blue sheds: Tidier stores, better displays and better merchandise.

He and Moghe believe it could make sense to axe the Bond & Bond brand, something Powell has not ruled out.

The Warehouse has given few details about what the acquisition will mean for its performance beyond a $4m to $6m boost to earnings before interest and tax for the half-year ending January 27. Powell also acknowledged it hasn't given details on what its plans are for the retail brand but says more information will be released in March when it announces its half-year results.

The group has its work cut out, with not all convinced the brand play will succeed.

One prominent retail figure, who did not want to be named, said some electronic brands "would move heaven and earth" to keep their products out of The Warehouse and, even if it got them, the move would likely fall flat.

"The customer perception of the Warehouse is that they sell cheapest price, poorest quality."

Brands become tainted by association, he says. He cites German appliance brand AEG's foray into The Warehouse about 15 years ago, which ultimately failed because of the mismatch between the perception of both brands.

But Powell says The Warehouse is unlikely to become the home of premium-end TVs and whiteware. The brand mix within its retailers will be "tweaked" but will need to remain very distinct so they don't cannibalise each other's sales.

The Warehouse has, somewhat tardily, moved to address quality issues with private label brands, including removing about 70 products out of 60,000-odd from its range, and its $130m store revitalisation programme should also help it win over previously reluctant brands.

"We've got no interest in damaging brands and no interest in not working well with partners who don't want to work with us. We're having very positive dialogues," Powell claims.

He dismisses AEG as "ancient history" and points to the likes of Telecom, Vodafone and Microsoft as examples of higher-end, key brands that have seen growth after moving into The Warehouse.

The electronics sector is on the rise, he says, achieving medium-term sales growth of 3.8 per cent despite price deflation.

He expects the scepticism, evident in a 5 per cent fall in its NZX share price this week to $2.94, will fade.

"The more people take time to really look at what this means, like us they'll come to the conclusion that this really is a game-changer in terms of how we're positioned as a group and how we're positioned to serve customers across all the brands."

Morris says the move is bold but calculated.

"They say they're the place where everyone gets a bargain. Well, they think they've got a bargain. The proof is in the pudding. Can they create value out of what they've bought?"

Waikato Times