Sell Kmart to transform Target – Credit Suisse

Wesfarmers must put Kmart up for sale to avoid the Target revival turning into a “zero sum game” for the conglomerate.


The transformation of Target can only be achieved at the expense of Kmart, according to broker Credit Suisse, and the sale of Kmart at its peak would give Wesfarmers the “flexibility” to adopt some of Kmart’s pricing strategies.

“The profit history of Target, Kmart and Big W all illustrate periods of significant out-performance and underperformance,” analyst Grant Saligari said.

“Largely, they have been playing a zero sum game.”

He said synchronising the profits of Kmart and Target had proven elusive given the history of discount retailers in Australia, a tale of how all three chains have never fired at the same time.

“A solution to this apparent dilemma for Wesfarmers could be to sell Kmart and, arguably at peak valuation, and then set about trying to fix Target,” Mr Saligari said.

“The approach has a reasonable chance of capturing the upside value of both businesses.”

Credit Suisse estimates Kmart alone will account for 75 per cent of the listed department store and discount department store profit pool this financial year and 17 per cent of profits in the broader sector.

To secure a greater share of these profits Target will need to strengthen its “value” proposition, according to Credit Suisse, which will ultimately put it in “closer competition with Kmart”.

Mr Saligari said the performance of Kmart, which reported a 16.3 per cent jump in earnings before interest and tax to $371 million for the first half, suggested it may be close to “peak profitability”.

Credit Suisse’s best-case scenario suggests Kmart could capture as much as 20 per cent of the broader discount sector in fiscal 2020, but only in the absence of any disruption from competitors, which the broker said would be a “surprising outcome”.

Woolworths is also battling the improve the profitability of its discount department chain Big W, which unexpectedly lost its chief executive last November before posting a 89 per cent slump in its first-half earnings to $8.1 million.

Wesfarmers would not comment on the research note, but market watchers say the conglomerate already has the flexibility to swap between the two brands with department stores chief Guy Russo in charge of both chains.

Credit Suisse also questions Target’s capacity to compete with the global, fast-fashion giants such as H&M and Zara, with fashion such a prominent part of the Target strategy.

Mr Saligari said Target’s brand was unlikely to have a strong enough pure fashion element to it despite Mr Russo’s recent claims that the chain’s scale and national distribution network will give it the edge.

“Probably because of these factors, fashion has been a difficult middle ground for discount department stores to occupy,” Mr Saligari said.

He said a better strategy for Kmart would be to “strengthen the value element of its offering and adopt a turnaround strategy analogous to Kmart.”

“Our observation of the pricing message in stores is that Target is taking precisely that strategy.”