O'Brien maintains Woolworths' subtle success

Woolworths' sales growth will inevitably be compared to Coles', but what this will not reveal is that Grant O'Brien's focus on leveraging his far larger sales and customer base is going exactly to plan.

When Grant O’Brien took the helm of Woolworths about 15 months ago he didn’t promise radical change but rather a sharper focus on the detail of the group’s businesses. He is delivering on what might appear to have been a modest aspiration but, for a group of Woolworths’ massive scale and pre-existing quality, is actually quite a very challenging task.

Across the range of Woolworths’ retail businesses the striking aspect of the group’s latest half-yearly result, and indeed the results since O’Brien became chief executive, has been the consistent albeit incremental improvement in the group’s key metrics.

Across the brands Woolworths is delivering respectable but not especially impressive growth in sales. All of them are improving their gross margins at meaningful, better rates than their costs of doing business, which translates into retail profit margin growth and ultimately solid bottom line growth. They are also pushing heavily into the online environment, with encouraging early results. Total online sales were up 40 per cent in the half.

In the key Australian food and liquor business, Woolworths lifted sales 4.7 per cent to $20.5 billion. Its gross margin improved 31 basis points, to 25.14 per cent, while its cost of doing business rose 17 basis points, to 18.2 per cent. Earnings before interest and tax as a proportion of sales, therefore, rose 14 basis points and EBIT 6 per cent to $1.65 billion.

While there will be the inevitable comparisons with its rival Coles group, which lifted its food and liquor earnings 15.1 per cent on a 4.8 per cent increase in sales for the same half, those comparisons are more useful in terms of measuring Coles’ progress in renovating its business than reaching conclusions about Woolworths’ performance. The size and strength of Woolworths’ food and liquor business makes it a benchmark for Coles, rather than the other way around.

Because the starting points are so different Woolworths’ own progress needs to be tracked against its own performance and, after a couple of lacklustre years where the group appeared to be coasting and complacently taking its dominance for granted, O’Brien is now delivering solid and high-quality growth.

He has tidied up the portfolio, exiting the troubled electronics sector and shifting $1.4 billion of property off his balance sheet through the creating of the SCA Property Group vehicle and the associated $500 million in specie distribution to shareholders, but Woolworths wasn’t in need of major renovation, just a tighter focus.

O’Brien has made a conscious decision not to be as reactive to Coles as Woolworths had been or to prioritise customer acquisition. Rather O'Brien wants to leverage Woolworths' enormous sales and customer base and turn the customer insights provided by its loyalty programs into more transactions with existing customers. A key aspect of that strategy is to make those customers more loyal.

With a 4.6 per cent increase in customers per week, to a remarkable 20.2 million, as well as increases in basket size and the number of items sold, that strategy appears to be working, while the increased attention on sourcing, promotions and the growth in exclusive brands is helping to control costs and allow that increased customer activity to flow through to earnings.

Generally the results were very solid but Big W’s improvement in what has been a very difficult period for discount store groups (other than Kmart) was worthy of note. It lifted EBIT 8.3 per cent on a 3.6 per cent increase in sales and a 110 basis point improvement in its gross margin, to 31.5 per cent.

A criticism of Woolworths in the recent past has been that it was more interested in pumping capital into store network expansions to build its top line lead over Coles than it was in the returns generated from that capital, which led to a steady and significant decline its returns on funds employed.

If the Masters hardware joint venture with Lowe’s of the US is put to one side, O’Brien has been steadily reducing his capital expenditures in absolute terms as well as a proportion of sales. He’s also pulled capital out of the balance sheet with the SCA transaction.

Since Woolworths’ return on funds fell from 17.7 per cent in the first half of 2009-10 to 15.4 per cent in the first half of 2011-12, it has stabilised at 15.5 per cent. If the investment in Masters, which is still in start-up mode, were excluded the return on funds would rise to 18.2 per cent and would again be moving strongly in the right direction for shareholders.

O’Brien is happy that the strategy is working and that the slightly re-positioned Woolworths business model is generating sustainable gains.

Despite the uncertain economic backdrop the progress the group has been making has encouraged a slight but positive change to the group’s full-year guidance, with after-tax earnings from continuing businesses expected to grow within a range of four per cent to six per cent rather than the three to six per cent growth previously foreshadowed.

That’s not a stunning growth rate, but it is consistent with the measured and consistent growth strategy that O’Brien said he would pursue from the outset.