Woolworths will receive a $200 million profit fillip and free up more than $300 million cash from winding up Masters, but its exit from the $45 billion home improvement market will leave the retailer with limited growth options, investors say.
Woolworths shares fell 30¢ or 1.3 per cent on Tuesday, giving up some of the gains from Monday, when chairman Gordon Cairns pulled the plug on the company's disastrous $2.8 billion foray into home improvement, saying the retailer could no longer sustain mounting losses and capital drain.
Fund managers said initial jubilation that Woolworths had bowed to pressure to quit Masters had been replaced by concerns over the company's growth prospects.
Mr Cairns believes Woolworths food and liquor businesses have plenty of growth potential and Woolworths will eventually "earn the right" to pursue expansion when the core businesses are back on track.
"We as a board believe there's still growth in supermarkets – we do not see it as ex-growth," Mr Cairns told The Australian Financial Review. "We are much more optimistic about the growth opportunities in supermarkets and we won't be short of options in which to spend our capital."
But investors are unconvinced, pointing to the fact that Woolworths' Australian food and liquor margins are still very high by global standards, even if they have come down from record levels in 2014. Sales per square metre in supermarkets are falling and Woolworths is unlikely to lift its 30 per cent share of the grocery market.
"I think it's good they're cutting their losses and moving on," said Watermark Funds Management investment analyst Joshua Ross. "But I see it as ex-growth for the next couple of years easily."
While Woolworths had racked up operating losses of more than $600 million in the past four years and invested more than $2.3 billion into the $3.4 billion venture, some investors had been clinging to the hope that Masters would eventually turn the corner.
Woolworths' exit from the $45 billion home improvement market removed the "blue sky" potential for sales and earnings growth and left the company with few options to expand into new categories.
The board and management did not have the backing of investors for new acquisitions so it was hard to see where growth could come from, Mr Ross said. They had to fix current formats before they tried to pitch new growth avenues to the market, he said.
"They've done the right thing," said one major shareholder, who declined to be named. "You can't keep carrying that sort of loss."
"But they're going to be growing at GDP – that's how the market is going to value them. They'll get population growth and some inflation and some growth in the other businesses – it's not GDP-plus any more."
Analysts believe Woolworths will have to book a non-cash impairment charge of at least $1 billion and as much as $2.7 billion this year against the $2.8 billion book value of the business.
However, Woolworths could realise between $240 million and $1 billion, after paying out Lowe's, by selling or winding up the business and use the cash to invest in its core food and liquor business or reduce debt.
"We believe Woolworths could receive [before costs] well over $1 billion in cash from the liquidation of [the home improvement assets] lowering expected interest costs considerably," said Merrill Lynch analyst David Errington, "boosting net profits and earnings per share by around 20 per cent in 2017."
Masters is considered by most analysts and investors to be unsaleable because of the size of its losses, but Mr Cairns says Woolworths is duty-bound to shareholders to explore all options for exiting the business.
If Woolworths is willing to sell the business at a steep discount to net assets, it could attract private equity or trade buyers willing to invest long term – and avoid giving rivals Bunnings and Metcash's Mitre 10 a free kick.
"Masters is worth $1.5 billion and to shut it down will cost $700 million so they'll end up with $400 million to $500 million. Woolworths will take anything above that," one fund manager said.
"An enterprising private equity buyer with a fabulous home improvement expert could offer $600 million to $700 million and they'd be buying a business for 30¢ in the dollar."
"If you were an American buyer at 68¢ and you offered $700 million, you'd be paying $US500 million," he said.