WEEKLY STOCK COMMENT: WOOLWORTHS (WOW)
Roy Davidson , 12 January 2017
Woolworths (WOW) is an Australian based retailer, primarily focused on food retailing. WOW’s major brands in Australia include Woolworths Supermarkets, BIG W and Masters home improvement. WOW’s New Zealand operations comprise the Countdown chain of supermarkets.
After a series of strategic errors, WOW has delivered poor financial results for a number of periods. Sales have declined across all its established businesses (the Woolworths grocery chain and Big W discount department store), and the company has lost market share. One of the main drivers of this has been the Masters hardware brand. WOW entered the hardware market in 2011, in competition to the Wesfarmers owned Bunnings brand. However WOW failed to make any significant inroads in the Australian hardware market, and the business was wound up in 2016. Whilst little of the A$2.1bn capital invested in this venture was recovered, the wind up has improved cash flow and allow the new CEO to focus much needed attention on Woolworths and Big W.
WOW has been investing in price in an attempt to turn around its struggling supermarkets franchise, which has resulted in margins falling significantly. In 2014, WOW’s food and liquor margins were 8%. These have recently fallen below 6%, due to lower prices, falling sales and operating deleverage. The WOW board appointed Brad Banducci (prior MD of Woolworths Food Group) as CEO in 2016. His focus has been firmly on the supermarkets business, and sales have started to improve as a result of a new strategy. As well as investment in price, WOW has worked hard on improve its stock levels, customer service, store layouts and internal culture. These initiatives are starting to deliver results, with recent sales showing some improvement.
WOW has delivered well above average EPS and DPS growth over the past 15 years, with its success attributable to its strategic focus on achieving a balance between growth and returns. Despite recent difficulties, WOW still has strong cash flow generation, a very solid balance sheet and an extensive store network serviced by an efficient supply chain coupled with intimidating buying power.
WOW is a big ship to turn around. Whilst we are encouraged by the exit of the Masters business and the recent improvement in sales trends from Woolworths, it will take time to drive earnings growth. Furthermore, the broader food retail sector remains challenging in Australia, with Aldi challenging the incumbents’ Woolworths and Coles, and inflation very low. We see the potential for WOW to once again become a high quality, defensive exposure to the domestic Australian economy, but the valuation is high for the limited earnings growth on offer.
Potential risks for WOW include 1) increased competition, 2) price deflation, and 3) economic downturn.