Woolworths takes a big bath

More writedowns will hit the 2016 result, but underlying earnings are within expectations and there’s early evidence customers are returning.

Only last month, we said in Woolworths: Competition cuts in that ‘we’re getting closer to a more emphatic Buy’. Today’s announcement from Woolworths takes us further away. Business turnarounds are rarely linear but the announcement was unequivocally good news. The market thought so too – witness the 8% jump in the share price.

What the market loved most was the underlying 2016 earnings before interest and tax guidance of $2,550m to $2,570m. We had been steeling ourselves – or perhaps secretly hoping? – that the 2016 year would be much more disappointing. It could have been worse than the 32% decline in underlying operating earnings Woolworths will report in August.

There was plenty more positive news too. The company reported a record ‘voice of the customer’ score, which measures customer satisfaction. This translated into growth in the number of transactions in June and into July. It’s very early days, but these are leading indicators that suggest a turnaround in same-store sales growth might emerge during 2017.

Key Points

  • 2016 earnings could have been worse

  • Early signs of turnaround continuing

  • Capital raising less likely

Another positive was that managing director Brad Banducci was as emphatic as he could be about a capital raising: it’s ‘not part of our current plan’ he said. With the company’s dividend reinvestment plan, potential asset sales and reductions in capital expenditure and working capital, management expects to have sufficient cash to continue the turnaround.

Rollout reined in

To that end, Woolworths intends to re-focus on improving its existing portfolio of stores rather than rolling more of them out. The six new format stores are performing ahead of expectations, with the company expected to roll out 82 refurbishments this financial year.

As always the good news was balanced with bad. Another 500 support staff will lose their jobs, various projects will be written off, 30 stores will be closed down, and impairment charges taken at another 54 stores or sites.

Big W, which will make a greater-than-expected loss of $12m-$17m in 2016, will incur further restructuring costs. And the acquisition of online apparel business Ezibuy has been declared a stuff-up, with the company writing off almost all the 2013 purchase price and putting it up for sale.

All up, Woolworths will incur another $959m of restructuring costs in 2016 – on top of the $3.2bn of Masters-related writedowns reported at the time of Woolworths: Interim result 2016. It looks a lot like big bath accounting, with Banducci obviously intending the 2017 financial year to be his fresh start.

Devolving responsibility

Banducci is also continuing down the Wesfarmers route of devolving responsibility to the individual businesses. Another 1,000 staff in the support office will be re-deployed in the individual businesses. This not only moves staff closer to customers and stores, but it improves accountability. Interestingly, Woolworths will split out the performance of its high-performing liquor business in its full year results; the other benefit is we’ll get to see food (and petrol) separately as well.

Getting the incentives right matters, as we said in Woolworths: Competition cuts in. So Banducci is introducing two other measures Woolworths will focus on, both of which will factor into the incentive scheme for senior employees. Increases in sales per square metre – a metric Woolworths needs to improve – as well as return on funds employed, should be beneficial to shareholders over the long term.

Today’s strong share price rise looks like something of a ‘relief rally’. The prospect of a very poor 2016 result and a capital raising seems to have been put to rest.

Nevertheless, Woolworths’ turnaround remains in its early stages. There’s still a risk of bad news over the next year, so it’s possible the share price is getting ahead of itself.

Only a month ago we were hoping for an opportunity nearer $20; today the stock is approaching a recommendation downgrade. We suggest buying on bad news rather than good but Woolworths remains a BUY for now.

 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.

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