Woolworths: Interim result 2013

If you had a list of wants for Woolworths half-year result, you’d probably find it has ticked every box: decent sales and profit growth, margin improvement, healthy cash flow, recent investments delivering results, ongoing investment for the future, a reasonable outlook statement and raised full-year guidance. And all this despite ‘challenging trading conditions’, demonstrating the resilience that was a key reason behind our upgrade last year in Put some Woolies in your basket on 23 Oct 12 (Long Term Buy – $29.20).

Total group earnings before interest and tax (EBIT), on continuing operations and before significant items, grew 6.1% to $1,935m, on a 4.8% increase in continuing sales. Continuing net profit before significant items rose 5.5% to $1,247m. After accounting for significant items arising (mostly in the prior period) from the now-sold consumer electronics division and the demerger of SCA Property Group, net profit was up 19% at $1,155m.

Core strength

As ever, the core Australian food and liquor business (which accounts for over 80% of total EBIT) was behind the result, with EBIT rising 6.1% to $1,584m on a 4.7% increase in sales, despite price deflation of 2.8%. But Big W and Hotels also performed well.

Big W achieved a 110 basis point improvement in gross margins to 31.5% and a 23 basis point rise in EBIT margins to 5.3% thanks to efficiencies from its new distribution centre at Hoxton Park and a change in promotional activity. Overall, Big W increased EBIT by 8.3% to $130m on a 3.6% increase in sales.

The Hotels business enjoyed a 19% rise in sales, thanks to acquisitions and the opening up of the Victorian gaming market. Hotels EBIT rose 21% to $141m.

Masters growth

Woolworths also continues to invest heavily in its new Masters Home Improvement franchise, with 10 new stores opening during the period, to take it to a total of 25. The company expects to have a total of at least 30 by the end of June and about 100 by the end of 2016. As expected the business is losing money at the moment – as reflected in the rise in central overheads including home improvement from $92m to $115m – but a 55% rise in sales to $637m bodes well.

Cash flow was healthy, although flattered by a $606m boost to creditors due to timing differences. Taking that out, operating cash flow was broadly flat, at about $1,700m, while a reduction of about $350m in capital expenditure gave adjusted free cash flow of around $800m (compared to about $480m in the comparable period), just enough to cover dividend payments in the half of $723m.

Woolworths continues to defend its treatment of suppliers in the face of the ACCC’s investigation (as does Coles). We’ll have to see what happens, but the ACCC will need to tread carefully as it may appear somewhat perverse for the competition regulator to take actions that would lead to higher prices for consumers. If Woolworths and Coles are pushing hard for lower prices from suppliers, then they appear to be passing those on to consumers due to the competition between themselves.

Dependable income stream

The stock is up 18% since 23 Oct, putting it on a dividend yield of about 3.8% and a price-earnings ratio of about 18 based on full-year dividend and earnings forecasts of about 132 cents and 188 cents respectively.

This stock is unlikely to blow the lights out, but by the same token it’s also unlikely to provide nasty shocks. If you’re looking for a dependable income stream with reasonable long-term growth prospects (in the region of about 5%-8%), then Woolworths fits the bill.

Following this result, the more optimistic scenarios that we outlined on 23 Oct 12 look slightly more likely, so we're raising our price guides a little and Woolworths remains a LONG TERM BUY.

Note: The model Growth and Income portfolios own shares in Woolworths.