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Warehouse risking its (red) shirt on 'every day low price'

Warehouse risking its (red) shirt on 'every day low price' sales strategy

By Nikki Mandow

Sept. 21 (BusinessDesk) - The “A” word lurks behind any conversation with The Warehouse Group - Amazon.

What to do about a problem like the world’s most profitable internet retailer setting up on your doorstep? Or about the exponential transformation of the way people buy stuff - towards online shopping.

The problem hit The Warehouse big-time in late 2016. Christmas shoppers at the Red Sheds - which bring in almost 80 percent of the group operating profit - didn’t shop like they used to, margins were severely squeezed, and the group ended up with its $20.7 million 2017 net profit being a quarter of what it had earned the previous year. That’s despite selling fractionally more in dollar terms than it had in 2016.

The company swallowed hard and made some big changes - the main one being abandoning the Red Shed’s traditional “hi-lo” sales strategy (where say a quarter of products are on super-special at any one time) and adopting the “everyday low pricing” model.

“Our customers are telling us they want a bargain every day rather than having to wait for a sale or special offer,” chief executive Nick Grayston said at the time.

So has it worked? On the surface, it doesn’t look like it - not yet at least. The 2018 annual result, announced today, saw retail sales up marginally, but most key numbers falling. Adjusted net profit was down 13 percent to $59 million, EBIT slumped 46 percent to $57 million, operating margin was down from 3.6 percent to 3.1 percent.

On the other side, the company's reported net profit was up 12 percent to $22.9 million.

It’s early days, Grayston said in an interview with BusinessDesk. It would have been easy to have made short-term changes - stripping costs out, he said. “But we would have seen a continued collapse in earnings. To regenerate profits we had to fix the fundamentals.”

That’s not cheap. Restructuring costs chewed up $8.7 million in the 2018 year and $12 million the year before, but the company had no choice, Grayston said.

He says the company is aiming to lift the group’s gross margin to 35 percent from 33.1 percent in the 2018 year and 32.6 percent in 2017. Meanwhile, EBIT margin is on track to lift to 7 percent by 2020, he says.

There is a lot riding on the success of the “everyday low pricing” strategy, says NZ Funds senior portfolio manager Josh Wilson, and little tangible evidence of its success as yet.

“Cashflows and dividend payments [16 cents this year] were again supported by asset sales, but the cupboard is starting to look a little bare.

“Property sales mean lease expenses continue to rise, increasing off-balance sheet gearing. The financial statements note a huge lease liability of $871 million will be recognised next year when accounting standards change. This could bring gearing into focus, particularly if earnings fail to rebound.”

Chair Joan Withers said 2018 "was a challenging year." And Grayston said the new strategy for the Red Sheds is risky.

“Our biggest risk is a refusal to change - our staff not understanding the need for change. Or our customers not understanding the change; not understanding the proposition that you get a bargain every day. The headline of ‘50 percent off’ is compelling and we have competitors still going to the market every day with that proposition.”

He says some figures are going in the right direction. Red Shed customers bought 6.6 percent more individual items than last year, and gross margin for that part of the business was 37.4 percent versus 36.8 percent in 2017. Net profit after tax was above indications.

“That’s encouraging given our stated intent to stop chasing unprofitable sales," he said.

Debt levels have been reduced by $56 million by selling a property and the company's financial services arm.

He said the move to the everyday low prices strategy has had other benefits - like saving $5 million from not printing special offer flyers. And slashing the number of products in store, because of instead of stocking four similar products and having one of them on sale, The Warehouse now only carries the one item.

“There are operational benefits from economies of scale,” Grayston says. And not constantly changing the price on items in store has “freed staff up to concentrate on serving customers”.

Meanwhile, Noel Leeming emerged as a bright star in the Warehouse Group firmament. Operating profit at the appliance and electronics chain has risen between 60 percent and 85 percent each year since 2015. It went from $19 million to $31 million between 2017 and 2018, meaning it considerably outperformed Warehouse Stationery, where operating profit slumped 32 percent to $10.6 million over the year.

The Warehouse Group bought Noel Leeming from Australian private equity investors in 2012, acquiring 92 Noel Leeming and Bond and Bond stores for $65 million.

Grayston says the Australian company had stripped costs out and the New Zealand chain was operating “just above breakeven”. Five years ago, everyone thought electronics stores would be killed by online retail, he says, with companies like Best Buy in the US and Dixon Carphone in the UK struggling.

“That’s turned around. People still want to be able to come and look at goods, to ask human beings questions. To resist Amazon, you need price comparability, you need to supply customers as fast, or quicker than Amazon.”

He says Noel Leemings’ installation arm, while only 2.7 percent of total sales, is growing and “very profitable”.

“It’s part of the overall offer. People are coming in and finding knowledgeable, trained staff that can advise them, particularly with bigger, smarter electronics... We’ve put a lot of training into our ‘passionate experts’.”

(BusinessDesk)

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