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Warehouse downgraded after 'non-core' Leeming buy

Brokers Forsyth Barr are questioning the strategic rationale of The Warehouse Group's $65 million Noel Leeming purchase and have downgraded the stock.

The NZX50 stock (NZX: WHS) closed up 3.3% yesterday to $3.10, on news of the deal. It started the year at $3, but has gained 24% since late June's price of $2.49.

In a research note issued last night, ForBarr analysts Andy Bowley and Chelsea Leadbetter say the Noel Leeming buy, announced yesterday, diversifies earnings away from The Warehouse's core general merchandise business.

"The move into specialty retailing creates additional risks," the note says.

"WHS has historically had mixed success in the stationery category and performance in Red Sheds has deteriorated for a number of years.

"We are unconvinced that management has the right skills and experience to add significant value to Noel Leeming."

ForBarr downgraded their recommendation from "hold" to "reduce".

Its analysts say the consumer electronics sector is highly competitive, with low margins and rapid price deflation in recent years.

"We question the attractiveness of the acquisition given the unfavourable market dynamics."

ForBarr has lifted its net profit estimates for The Warehouse in the 2013 and 2104 financial year, to $73 million and $77.8 million, respectively.

However, in the absence of "significant synergies" the analysts describe the transaction as "returns dilutive".

Warehouse chief executive Mark Powell says it will fund the acquisition from existing debt facilities.

The consideration of $65 million was for all shares in the Noel Leeming Group and The Warehouse will not assume any of Noel Leeming’s $113 million of bank debt with Bank of Scotland, he says.

The Noel Leeming group was owned by funds controlled by Australian private equity firm Gresham, which led a $138.5 million management buyout from Eric Watson's Pacific Retail Group in 2004.

dwilliams@nbr.co.nz
dbridgement@nbr.co.nz

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Comments and questions
8

The sound you can hear is suppliers and competitors hearing news they've always dreaded.
Briscoes and The Warehouse main difference = lack of brands.
Do suppliers pull out of NL group or allow The Warehouse to stock brands?
By default, Briscoes and to a degree Harvey Norman has large share of small appliance market.
Owner-operated electrical retailers have lost F&P in more ways than one, owners are aged and Kiwis have no loyalty.
Rod Duke will be very worried his golden run may be ending.

The consumer electronics market is great for buyers but brutal for retailers. Noel Leemings, Bond and Bond and Dick Smiths - all bleeding red ink.

Head office synergies would save heaps of money as well as flicking closed-down Bond and Bond stores and selling the property if it is owned. Also possible to grow financial services with Warehouse and Noel Leeming combined. Plenty of possible synergies but it depends if management can take advantage of the opportunities. It looks like a cheap buy to me, with plenty of upside.

Dump Warehouse now. Everything's going online aka Trade Me.

I see this as a good buy if only for the property consolidation options that will be available in certain locations like Newmarket, for instance, where Bond and Bond is adjacent to the Noel Leeming store. With no debt, Noel Leeming can actually return a profit also.

You think they would have learnt after buying Silly Sallys, etc. Why the hell they would buy a non-profitable business that cannot have many improvements made and sales are going all online is beyond me.

What are ForBarr thinking? And a few of the WHS mgt are ex-Noel Leeming. Downgrade the stock, even with earnings set to rise. Smart move for WHS - sell some property making little return and buy Noels for a steal with operating profit (now 10mil in interest charges has gone).

Looking at NL 2012 annual report, they had around 81 million of stock "inventories" at balance date.

NL would still have to have around the high 70 million stock holding so WHS has basically paid less than stock value for the whole operations.

If it doesn't work, close the NL down and it costs them nothing.