Don't discount a takeover for Woolworths
With Woolworths (ASX: WOW) reporting its 2015 results last Friday, the company continues to make news. Unfortunately it’s the wrong kind of news.
A poor 2014 Christmas, lagging sales growth and losses blowing out at home improvement start-up Masters have been followed by the resignation of chief executive Grant O’Brien. A few weeks ago the head of the struggling Big W chain left after a staff complaint, then on Friday chairman Ralph Waters announced he was stepping down.
Woolworths is effectively rudderless. There is little doubt that the new chief executive – when he or she is appointed – will come in with a mandate to slash profit margins. Woolworths reported earnings per share of $1.97 in 2014 and that will probably represent ‘peak profit’, at least for a few years (whether we’re at ‘peak beard’ is still uncertain).
What all this bad news ignores is that Woolworths is a wonderful business. Its food and liquor division is still 37% larger than the Wesfarmers-owned Coles (ASX: WES) in revenue terms. Its larger size alone suggests long-term sustainable margins should be higher than those of Coles.
Woolworths operates the best liquor business in Australia, as even Coles itself would concede. Masters and Big W might be struggling but Woolworths’ hotels and its New Zealand supermarket chain are doing just fine.
In short, Woolworths is a business we’d love to own and recommend to members. Remember this over the next 18 months as bad news and dire headlines dog the company. Any opportunity to buy will come becausethe headlines are bad and others are losing interest.
On Friday we published Woolworths: Result 2015, which put a few valuation stakes in the ground and the price at which we would upgrade the stock to Buy. Woolworths’ margins are only just starting to decline, so there’s almost certainly more bad news on the way.
If we have our eyes on Woolworths, then others might too. Leaderless companies like Woolworths often attract the attention of predators. While there’s talk that buyers are lining up for Big W and Masters, could a bidder be sizing up the entire company?
Perhaps so, although a takeover bid would require deep pockets. It’s unlikely the directors would accept anything less than $32 a share, which would value the equity at more than $40bn.
Private equity consortium
Private equity buyers would probably struggle to finance a bid that large, although anything’s possible if they formed a consortium.
Our bet for most likely bidder would be Wal-Mart (NYSE: WMT), the US retailing behemoth. It already owns Asda, one of the UK’s four largest grocery chains (with 16% of the market). The UK grocery market is much more competitive, so Wal-Mart might be attracted to the duopolistic nature of Australia’s market (notwithstanding the incursions Aldi is making).
In fact, Wal-Mart already has a significant relationship with Woolworths. Roger Corbett, a former chief executive, is on Wal-Mart’s board of directors, while Greg Foran, another former Woolworths wunderkind, is the President and chief executive of Wal-Mart US.
Any Woolworths recommendation will have to stack up on its own merits, of course. Intelligent Investor won’t upgrade the stock until we feel it represents value.
But we’re also mindful that this is one of Australia’s best businesses. Profits might decline for a year or two, but this should still be a great business ten years from now. Whether it will still be listed on the ASX is another question entirely.
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