Woolworths: Result 2017
Recommendation
From the 28% lift in the share price since the dark days of Woolworths: Competition cuts in, you'd be forgiven for thinking Woolworths' supermarket business was growing earnings again. But no, Australian Food – as the company calls the division – saw operating earnings fall 2% to $1,603m in 2017. In fact, the operating margin slipped again – from 4.7% to 4.4%.
Never fear, higher earnings lie ahead. With Australian Food margins slashed from 8% at their peak and grocery prices now more competitive, customers are once again picking Woolies. As a result Australian Food sales grew by 5% to $36bn, with same-store sales growing by 6.4% in the fourth quarter. Woolworths' gain has been Coles's loss, as you would have seen in Wesfarmers' result last week.
Despite the decline in Australian Food's earnings, a lot's been going on behind the scenes. A 0.7% increase in the gross margin added almost $700m to gross profit dollars, partly due to a focus on reducing stock losses (losses from damaged fruit, stale bread etc.). Also, a 1% lift in the cost of doing business – as management increased training, team incentives and staff hours in store – will produce benefits as sales continue recovering.
Key Points
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Strong second half for Australian Food
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Big W lagging competitors
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Balance sheet improving
This was already evident in the second half, with operating earnings rising 13%. In 2018, Australian Food's earnings and margins should return to growth.
Elsewhere, Endeavour Drinks performed brilliantly, taking market share. Sales and operating earnings both grew 4% to $7.9bn and $503m respectively. Hotels did even better, with a 12% lift in operating earnings to $233m thanks to strong bar sales (perhaps shareholders were drowning their sorrows).
Thankfully these divisions are performing well because they'll need to help offset weakness in New Zealand and Big W this year. While New Zealand Food earnings fell just 1% to NZ$309m in 2017, management flagged a pre-emptive reduction in prices and an increase in service levels across the ditch in 2018. In other words, earnings will fall.
House of horrors
Big W is a house of horrors. In 2017 sales fell 6% to $3.6bn and it reported an underlying operating loss of $115m (most of it in the second half). The division's revolving door of management means Woolworths' board only signed off on the turnaround plan a few months back.
The plan seems partly a copy of – and partly a response to – Target's own plan. Target is moving away from brands; Big W will continue to offer them. Big W wants to attract mums into stores with kids' merchandise; Target dumped its toy sale because it wasn't profitable. Presumably Big W needs to differentiate itself somehow but the new plan seems mainly defensive to us.
Year to 25 June | 2017 | 2016 | /(–) (%) |
---|---|---|---|
Revenue ($m) | 55,475 | 53,474 | 4 |
EBIT ($m) | 2,326 | 2,446 | (5) |
Net profit ($m) | 1,422 | 1,476 | (4) |
EPS (c) | 110.8 | 116.8 | (5) |
DPS (c) | 84.0 | 77.0 | 9 |
Franking (%) | 100 | 100 | n/a |
* Final dividend $0.50, up 52%, ex date 7 Sep |
Contrast that with Guy Russo's aggressive approach at Target. Russo let Target's sales plunge 15% in 2017 as he eliminated unprofitable products and events. In return he was rewarded with a breakeven result during the year. Big W's horror show is forecast to drag on; management flagged a ‘stabilisation' of sales in 2018 but another big loss.
Excluding discontinued operations (the petrol business and the Masters imbroglio, but let's not get into that), Woolworths' total sales rose 4% to $55bn, while operating profit fell 5% to $2.3bn. Net profit was down 4% to $1.4bn, and a fully franked final dividend of 50 cents, up 52%, was declared (see Table 1). Of course, Woolworths' 2017 annual dividends were 60% below their 2015 level, so nobody's fooled by that increase.
Cash flow jumps
Highlighting strength of the Woolworths business, it seems our concerns about the balance sheet – see Woolworths competition cuts in – were misplaced. Helped by inventory reductions, free cash flow jumped 73% to $1.5bn in 2017. Woolworths managed to repay $1.2bn of debt during the year, ably assisted by shareholders accepting a halving of their dividends.
Chairman Gordon Cairns will be pleased. After taking the job in 2015, he set about cleaning up the Masters mess and appointing managing director Brad Banducci to fix the biggest problem of all – Australian Food. Banducci has been impressive and shareholders – despite lower dividends – have him to thank for a well-executed turnaround plan.
For now, higher earnings might lie ahead but the share price takes it all into account. On a price-earnings ratio of 24, the market's expecting a few decent years of profit growth. Woolworths might be a great business but the best we can manage at present is HOLD.
Note: The Intelligent Investor Equity Income Portfolio owns shares in Woolworths. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.