Getting Target on track will be an uphill challenge

Wesfarmers’ decision to write down the value of its Target business by $680 million confirms what was already suspected: the once-stellar brand’s issues are structural and are going to take quite a long time to address.

The impairment charge against the goodwill in the Target business -- 35.2 per cent of the $2 billion or so of Target goodwill Wesfarmers had been carrying in its books -- is a non-cash item and will be offset by the profit of just over $1 billion Wesfarmers will record from the sales of its insurance businesses.

It is, however, an indication of how intractable the issues within Target are, and how far the brand has fallen since Wesfarmers acquired it and its Coles’ siblings in 2007. Target was the jewel in the Coles group’s crown, with a long history of having the best profit margins in the sector.

Wesfarmers said today that the decision to write off the goodwill followed a consideration of its expected earnings for the 2013-14 financial year, its 2015 financial year operating budgets and the longer term divisional outlooks.

Target is expected to produce earnings before interest and tax this year within a range of $82m and $88m. Last financial year Target’s EBIT was $136m and in the 2012 financial year $244m. It was only a few years ago that Target was generating around $280m of EBIT in a half-year.

Wesfarmers transferred one of its senior Coles executives, Stuart Machin, across to Target last year in an attempt to turnaround its fortunes. Machin has put a new leadership team in place, slashed jobs, cut costs, dumped excess stock, is reducing the range of products, invested in service and the stores and introduced more consistent pricing, among other things.

Machin has, however, made it clear that there are no instant fixes for Target and is working within a four-year plan to remake the brand. Wesfarmers’ managing director Richard Goyder said today the group was pleased with the progress made in strengthening Target’s leadership and believed there were many opportunities to significantly strengthen its performance.

Target, of course, isn’t the only discount department store group with issues. Woolworths’ Big W brand’s new managing director, senior UK retailer Alistair McGeorge, joined the group last month to oversee a major transformation of that business, which experienced a 5.9 per cent decline in comparable stores sales in the third quarter and whose earnings have also been declining.

Both discount department store groups have been impacted by the focused volume and price-driven model Guy Russo implemented at Kmart, which has proved immensely successful for Target’s once-struggling sibling -- and immensely disruptive to the rest of the sector and their suppliers.

The generally soft and still-weakening conditions for retailers generally haven’t helped in the post-financial crisis period. It is also feasible that discount department stores have been particularly impacted by the rise of online shopping, given that online retailers generally target price-conscious consumers.

Along with the hefty impairment charges against Target’s goodwill, Wesfarmers also announced a provision for the restructuring of Coles’ liquor business of $94m.

Coles’ new managing director John Durkan has made it very clear that one of his priorities is to improve the performance of its liquor businesses, a sector where arch-rival Woolworths sets the benchmarks. Coles plans to reshape its store network and improve store productivity, rationalise its product range, improve its offer and increase its efficiency.

The Target impairments and the provision of the restructuring of the liquor businesses will be more than offset by the profits from exiting insurance, although they will reduce the net gain from significant items this financial year to between $261m and $301m. It is a good time for Wesfarmers to absorb one-off charges that will incidentally help it improve its returns of capital.

Wesfarmers also made the point today that, while the accounting standards don’t allow it revalue its businesses positively, it has created a lot of value (far more than the Target impairments) within Coles, Kmart and Officeworks since their 2007 acquisition. It's impossible to argue against that conclusion