Woolworths results all over the shop

Within what is quite an opaque Woolworths result, one disfigured by a near total writedown in the value of its consumer electronics business, there were some tentatively encouraging elements.

That may not have been immediately apparent, with statutory earnings falling 14.5 per cent, Woolworths' first earnings decline in more than a decade, and its profit before the Dick Smith writedown of $420 million up a modest 3.6 per cent.

The obvious reference points are the Wesfarmers' retail brands, and the comparisons aren't flattering to Woolworths, although the sheer scale of Woolworths and the reality that the Wesfarmers' brands are realising their renovation potential, whereas Woolworths has been a first-class retailer for a long time, makes that a misleading comparison.

A 6 per cent increase in the earnings before interest and tax within the core food and liquor business provided the core of a solid result in difficult circumstances, with the group experiencing severe price deflation. There was a modest improvement in gross margin offset by an increase in the costs of doing business but overall it was a very respectable result.

Even more encouraging was the 0.8 per cent rise in EBIT within the Big W discount department store business. Big W has been at the sharp end of the difficult retail conditions and heavy discounting and its earnings have been falling. In the second half, however, its earnings rose 13.1 per cent despite virtually flat sales.

The query over that performance is that most retailers appear to have ended the financial year more strongly and it is unclear whether that reflects an underlying improvement in the market and more confident consumers, or is an aberration in a recessed retail environment caused by the latest federal government 'cash splash'.

First quarter sales results for this financial year will shed some light on that, although Woolworths' Grant O'Brien appeared to indicate today that the fourth quarter tone had extended into the start of this year.

The difficulty in interpreting the Woolworths' results is that, apart from the Dick Smith writedowns in preparation for its sale – it now has a book value of only about $20 million – Woolworths is in the midst of two major expansions.

The most visible is the continuing rollout of the Masters hardware chain – it is opening a new outlet every 2.4 weeks and now has 20 stores up and running – at a cost in the 2011-12 year approaching $100 million. It will be some years before a sensible judgment on that strategy can be made.

The other is an aggressive expansion of the food and liquor business. Woolworths opened 38 new supermarkets in the year just ended and plans to open another 35 this financial year.

The continuing growth in its footprint is reflected in the $2 billion of capital expenditures the group made in the year and the $2.3 billion it expects to spend this year, nearly half of which relates to property developments.

That heavy investment in expanding its store networks has been a drag on Woolworths' previously stellar returns on funds employed and shareholder equity in the past and is pushing up its costs of doing business and therefore has attracted some criticism within the market.

Excluding the Dick Smith business, Woolworths return on funds employed slipped from 30 per cent to 28 per cent. If Masters and the property developments were also excluded it edged down from 35 per cent to 34 per cent. The return on shareholder equity, also excluding the Dick Smith provision, fell from 28 per cent to 27.2 per cent.

Even though it has bought back about $1 billion of capital in recent years Woolworths has, because of the weight of the capex program, been unable to reverse the slide in its returns. Until both the Masters rollout (which Woolworths says will cost it about $80 million net this year) and the supermarket expansion spree are more mature it won't be possible to get a clear picture of their impact on underlying returns.

The group's cost of doing business edged above 20 per cent (20.18 per cent to be precise) for the first time in five years but would still have been higher than at any time during that period, at 19.94 per cent, even if the impact of Masters were excluded.

That has to do with store and distribution centre openings and may be reversed once O'Brien's five-year "Project Quantum" cost reduction program starts to have an impact this financial year.

O'Brien's guidance for this year is understandably cautious. He expects earnings from his continuing operations to grow within a range of about 3 per cent to 6 per cent, with the caveat that retail conditions in Australia and New Zealand remain challenging and consumer confidence remains low.

If Woolworths is to resume the powerful growth trajectory that the market once took for granted, however, it won't be this financial year that the adjudication on the wisdom and impact of the massive investment in greenfields expansion is made. That will have to wait three or four years.