Woolworths boss Brad Banducci invited 10 of the big broking houses for lunch in Surry Hills on Friday. It was a tough, cynical crowd – most of the analysts have "neutral" or "underweight" recommendations on the stock – but his message was clear: it will be a hard recovery, there is a lot to do, but change is coming.
Banducci's work isn't just about fixing the mess left by the previous senior management and former directors, but trying to win back the trust of investors and analysts. It has already started winning back customers and anecdotally supplier confidence is starting to improve.
But it will be a long and bumpy journey. How bumpy it will be will be heavily dependent on major rival Coles.
It is at a critical juncture. Will Coles launch a price war, which will turn into a race to the bottom? Or will there be sensible pricing between the two giants?
Some hedge funds are punting that Coles will embark on a savage price war, Woolworths will retaliate, which will drive down margins, profit and the share price. It is why the stock is still being shorted by the hedge funds, albeit far less than it was 12 months ago.
But not everyone is convinced. There has been a fundamental change at Woolworths – a new senior management team including chief executive, a revamped board, strategic changes and a commitment to match Coles in any price discounting.
Indeed, a recent survey by Credit Suisse found that a basket of more than 100 groceries at Woolworths cost less than a similar basket at Coles.
It is early days and there are a lot of sceptics and haters but it is far from a lost cause. Woolworths has the biggest supermarket footprint in the country, the best liquor chain business, a strong gaming and hotel operation and it has spent a lot of money over the years to develop a world-class supply chain.
It is why some people are wondering whether Coles will try to deal a body blow via a price war before Woolworths starts to rebound.
It is what Woolworths should have done to Coles back in 2010 when Coles was underperforming. If Woolworths had instigated a price war in its supermarket business, it would have crushed Coles at its most vulnerable.
Back then, Woolworths was sitting on fat margins. Wesfarmers had bought Coles at a high price, putting pressure on the conglomerate's balance sheet and share price.
Instead of attacking Coles, it went after Wesfarmers' jewel in the crown, Bunnings, by moving into hardware. The theory was if it could create trouble for Bunnings, it would reduce Wesfarmers' ability to turnaround Coles.
This was a strategic mistake, not just because of a poor execution of its hardware strategy, but because Coles wouldn't have had the firepower to properly fight back.
Fast forward to today and if Coles decides to land a killer punch today by using its margins to launch a wide-scale price war, Metcash, Aldi and Woolworths would have to follow suit, which would be a win for customers but a loss for the industry.
It is why a price war would be surprising in any sustained or wide-scale manner. It would crunch Coles' earnings at a time when some key parts of the Wesfarmers empire are struggling.
Wesfarmers owns a portfolio of assets including Coles, Target, Kmart, Bunnings, Officeworks, chemicals, energy, fertilisers, resources, industrial and safety (it recently combined some of these businesses into one unit).
Bunnings has been a consistently stellar performer, run by the highly regarded John Gillam. Coles is also a powerhouse, along with Officeworks and Kmart.
Wesfarmers is one of the last standing listed conglomerates on the ASX. Over the years it has managed to convince shareholders that the portfolio model works, despite the fact that conglomerates have been out of fashion for decades.
But in recent months, its performance should give investors pause for thought.
It has also found itself in some embarrassing situations including revelations that it was using rebates from international suppliers to artificially tart up Target's half year earnings by as much as $21 million.
There are questions whether it is too big, too diversified and whether it is making the smartest decisions. Some fund managers argue that if they want the benefits of diversification they can buy different stocks instead of having them all under the one umbrella.
Leading retail analyst Bank of America Merrill Lynch's David Errington didn't pull any punches in his latest note. Titled, "Overvalued – portfolio management disappoints; industrial supply should be impaired $1 billion", the note argues that Wesfarmers has underachieved in portfolio management.
"Over the past four years, Wesfarmers has disappointed in the critical area of portfolio management. Its strong performers have been more than offset by its poor performers in earnings contribution because it didn't divest poor performing assets. In our view, the premium value afforded to Wesfarmers shouldn't apply."
Errington's note, published on May 30, came days after Wesfarmers announced impairment charges of more than $2 billion on its Target and coal businesses, along with $145 million in restructuring costs and provisions in Target. (Errington had written a prescient note before that announcement flagging the need for some serious impairment charges on its assets).
But in this note he wrote that he was "surprised" Wesfarmers didn't impair its industrial supply assets by at least $1 billion. "It seems only logical that if trading conditions are structurally challenged for Curragh/coal industry then industrial supply would also face the same such conditions."
Not to put too fine a point on it, between 2012 and 2015, the strong performing businesses, Coles, Target and Bunnings, increased EBIT by $838 million, but the poor performing businesses went backwards by $663 million.
On Merrill Lynch's numbers, between 2012 and 2016, the strong businesses EBIT is expected to increase by $1.1 billion but the poor performing businesses EBIT is expected to decline by $1.35 billion – more than wiping out the EBIT contributions of the strong businesses.
It has prompted criticism that the board and head office should have been more nimble when it had the opportunity to sell its coal business for billions of dollars. The opportunity slipped by and now that business is bleeding red ink.
Wesfarmers did well when it headhunted Ian McLeod to run Coles. He and his team managed to put the supermarket giant back on track. But luck was also on their side when Woolworths dropped the ball back in 2010. The question now is whether it is Woolworths' turn to have some luck as it embarks on its own turnaround given some of the challenges facing parts of the Wesfarmers empire.
