Woolworths: Interim result 2014

You know you’re dealing with a predictable company when it refines its earnings guidance for the full year – four months out – from 4–7% growth to 5–7% and it gets described as an upgrade.

Woolworths boss Grant O’Brien was even more specific, saying that for the company to hit the top of that range, ‘consumer sentiment and consumer activity will have to be in a very strong place’.

The top of that range seems to be the least everyone expects from Woolies on an ongoing basis. Management’s stated aim is to get its earnings growth up to 10% and the market seems to be concerned that it might not achieve this.

The latest half-year results will have fed these concerns, which is no doubt why the shares dropped on the day despite the 'upgrade'. But at the same time it showed a very solid business chugging along with what in our opinion is plenty enough growth to make Woolworths an attractive investment.

Overall, underlying earnings before interest and tax from continuing businesses rose 5.9% to $2bn, on a 6% increase in revenue to $31.9bn. Underlying earnings per share rose 5% to $1.06, out of which a fully franked interim dividend of 65 cents will be paid (ex date 17 Mar), also up 5%.

Big W weak

Big W was the chief disappointment, with like-for-like sales slipping 2.3% in the half and earnings before interest and tax (EBIT) falling 7%.

This is partly as expected due to a reorganisation to focus on ‘categories of high customer importance’ (presumably ‘stuff that sells’). But there was a subtle shift in language: at the full-year results we were told that ‘profitable growth will remain but we may have lower sales growth during the transition’, but now we hear of the changes ‘impacting sales and profit in the short term but delivering profitable growth over the medium to long term’.

Evidently Big W has some tough years ahead of it. And since its longer-term future is clouded by the threat of the internet, you’d have to say that things don’t look great. Still, with Big W set to make more than $170m in EBIT in the current year, there’s plenty of breathing space above the $134m we outlined as our ‘disaster scenario’ for the division when upgrading the stock in Put some Woolies in your basket on 23 Oct 12 (Long Term Buy – $29.20).

We have higher hopes for the Home Improvement division over the long term, but that too had a disappointing first half, with the new Masters format being slower than many would like to gain traction. Seven new stores were opened in the half, but management said this was three more than planned and that it remains ‘on track’ to open 18 stores in the current financial year.

We applaud Woolworths for setting out to build such a large business organically rather than just making acquisitions, but these things take time and we’re happy to give the company plenty more of it (see Woolies under the hammer from 28 Jun 13 (Buy – $33.09) for more on the Masters joint venture).

Supermarkets strong

These disappointments were offset by EBIT increases of 16% and 10% by the Hotels and New Zealand Supermarkets divisions (the latter assisted by the stronger NZ dollar), but Woolworths’ short, medium and long-term performance will be dominated by the Australian Food and Liquor business, which contributed 83% of group EBIT in the half. This business also had a good half, increasing like-for-like sales by 3.0%, with 3.4% growth in the second quarter. The EBIT margin was a remarkable 7.9% (up from 7.7%), to give a 6.7% rise in EBIT to $1,692m.

All this came despite average price deflation of 4.1% in the half, and was driven by ‘improvements in buying, more effective promotions and growth in … exclusive brands, including Liquor’. The total number of supermarkets reached 920 at the end of December, with 23 new stores opened during the period – an increase of 2.6%. Thirteen store refurbishments were also completed.

The expanding store network and the Masters joint venture are plenty for the company to be going on with, and our biggest concern remains that management might try to do too much. O’Brien seems to be exercising good discipline, however, and any moves are unlikely to be hugely significant compared to the core Australian supermarkets division.

With dividends of about $1.40 expected for the current year, the stock is on a fully franked dividend yield of about 4%. Adding growth of 5–7% would imply a long-term total return of around 10% a year, which is attractive given its reliability. However, those looking for higher returns are unlikely to find them here. The share price is barely changed since Woolworths: Result 2013 on 30 Aug 13 (Buy – $35.20). BUY.

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