bite the hand that feeds you..

Bunnings gives Wattyl the big brush-off
June 13, 2009
Trying to turn the embattled paint maker around just got harder, writes Ian McIlwraith.

WALK into a Bunnings store and you will no longer find Wattyl among those huge paint displays that home renovators pore over in search of the perfect colour scheme.

The hardware giant, which accounts for about 30 per cent of paint sales in the do-it-yourself market, reviewed its paint suppliers last year, with all three local manufacturers losing some shelf space to Nippon Paints.

Wattyl, Australia's second-largest paint maker, lost the most ground in what the industry calls "broadwall" paints in the core architectural and decorative paints market. Sales of those A&D paints are about $1 billion a year, both trade and retail.

When Wattyl was looking at merging with rival Taubmans in 2006, the Australian Competition and Consumer Commission chief, Graeme Samuel, rejected the deal after finding that 90 per cent of sales were in the hands of the big three makers - Wattyl, Taubmans and industry heavyweight Orica's Dulux arm.

While Wattyl's exterior paints, like Solagard, and timber finishes, such as Estapol, are still in Bunnings stores, Nippon dominates the shelves and its arrival has seen the paint companies spending far more marketing dollars than they have for years. Both Bunnings and Wattyl reject suggestions that the retailer's attitude was jaundiced by Wattyl locating too many of its budget-priced Solver paint stores near the hardware outlets and draining off business.

The chief operating officer for Bunnings, Peter Davis, says Nippon was one of three foreign makers (the others were from the US and Britain) to knock on its door early last year looking to supply it with paint. Ironically, the ACCC's rejection of a Wattyl/Taubmans merger was partly based on its belief that it was not economic for another maker to import the stuff. Two years later, Samuel's commission has been proved wrong, with Nippon importing paint from Singapore to stock the shelves of a single customer, Bunnings.

And Wattyl is now at a corporate crossroads. It posted a loss in the December half, revised down its forecasts for the full year late last month, and is struggling with a mountain of debt.

Not only has it had to deal with the financial pandemic and consequent slowdown in the building trade, but the Bunnings decision coincided with two other contracts with Big W and Danks Holdings falling by the wayside.

Wattyl's managing director, John Nolan, reckons it is still strong in the trade market (its business split is about 60 per cent trade and 40 per cent retail) and is fast reducing its debt.

In January, Westpac and ANZ gave Wattyl a new $100 million credit line, $15 million of it as overdraft, but with tough covenants that left it unable to pay a dividend until gearing comes down and with a need to lop $22.5 million off debt by September.

Nolan had net debt down to $61 million by last month, but has also had to sell some properties to generate more money. He does acknowledge, however, that the group faces a huge task in rebuilding its sharemarket reputation. The stock has been below 50c a share for most of the time since it reported a $5.6 million loss in February and its current market capitalisation of less than $40 million is not even 10 per cent of the sales its generates each year.

"I think you have to do two things," Nolan said. "You have to get the operating performance back on track and you have to get the debt down. You have to do both these things - and people have to understand they are done."

Three years ago it had two bidders offering more than $3 a share and an independent valuation at more than $4. While shareholders were treated to a bumper 40c-a-share special dividend to buy their loyalty at the time, the failure of both takeovers and the debt accrued to pay for that dividend has meant deep losses for investors who have hung around.

Many of Wattyl's institutional investors have been selling, either down or out as the price slips lower and lower. There are two exceptions: the fund manager Hunter Hall Investment Management bought aggressively from last October to pick up 18.1 per cent (it is still buying, but has not had to tell the market yet) and the De Fazio family from Melbourne has spent almost $2 million acquiring a strategic 5.2 per cent stake at about 41c a share.

It is not the De Fazios' first foray into Wattyl. They advised Allco Equity Partners in its unsuccessful $3.25-a-share bid in 2006. That offer triggered the Wattyl board's attempt to get into bed with Taubmans.

The De Fazios' aim is not clear, and their spokesman, Frank De Fazio, will not comment.

And last week Wattyl appointed as a director Ian Fraser, who specialises in restructuring and reinvigorating companies (or trying to). He says it is reading too much into it to see his arrival as an indicator of the depth of the company's troubles, and his strength is industry knowledge from running Australian Chemical Holdings more than a decade ago.

Still, he happens to be something of a favourite with Hunter Hall, and sits on the boards of at least two other companies where Hunter Hall has significant stakes. Hunter Hall has spent just under $11.8 million, at an average 77c a share on Wattyl — which means it is $4.5 million underwater at yesterday's 46c closing price.

The chairman, Peter Hall, is a fan of the stock's potential. At a roadshow in March he defended the investment, arguing that the shares are probably worth up to five times their current market price.

He said the company could not continue to run all three of its paint plants - in Melbourne's Footscray, Kilburn in northern Adelaide and the largest at Blacktown in western Sydney.

"Something that definitely must be on the agenda for Wattyl is to close one of these three factories and rationalise production," he said, pointing out that the it was currently running single-shift operations and needed to move that to at least double-shift to justify the capital invested in the plants.

It is not a novel idea. The company's own work looking at closing its aged Blacktown plant was leaked in 2004, and analysts have been mulling the concept ever since.

The problem is that the estimated $40 million to $50 million it would cost to shut a plant - and the Sydney operation is more likely than those in Adelaide and Melbourne - is money the company does not have and is unlikely to have for at least a year. Nolan says he has taken any closure proposals off the agenda, insisting that the $20 million-plus of cost-cutting measures he has already taken have vastly improved efficiencies at all plants, and that closing one would not represent a great gain.

The hard work has, he thinks, been done. Investors just have to wait and see how good Wattyl looks with a bit of economic sunshine reflecting off its new paint job.