Business 16.1.2018 10:10 am

Woolworths faces the eye of the storm

Woolworths| Supplied

Woolworths| Supplied

Latest trading update confirms worrying outlook for Woolworths in SA and Australia.

Ian Moir, the straight-talking Scotsman at the helm of Woolworths, was unusually bearish about the retailer’s outlook at its annual results presentation in August last year.

Woolworths, which earned the title of “SA’s retail darling” for staying resilient during uncertain times, is in the eye of a storm. “It’s going to be tough. We are under no illusions about that… margins [a key metric for measuring profitability in the retail industry] will tread down over the medium term,” Moir told analysts.

But investors didn’t expect the extent of Woolworths’ woes, which first came to a head in a grim sales update two years ago.

Woolworths is facing many battles: declining clothing sales as a result of aggressive promotions by competitors, SA’s moribund economy and the burning of cash in turning around the fortunes of its Australian business, David Jones. Woolworths completed its ambitious R22 billion acquisition of David Jones and sister retailer Country Road Group in 2014 – tipped to turn it into a substantial retailer in the southern hemisphere.

Some investors were nervous at the sheer scale of the acquisition while others cheered the bold move Down Under over concerns that Woolworths had limited growth opportunities in Africa.

But the excitement around David Jones and Country Road fizzled out in 2016 when sales growth began to lag those of average department store sales in Australia – 12% versus 5.3%. It became clear that management could not deliver on their overzealous expectations from the Australian operations.

In two years, its share price has sunk by 43% from highs of R105.66 in November 2015 to R59.85 at the time of writing. Woolworths, a JSE top 40 stock, featured in the list of top ten worst performers in 2016.

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The latest sales update underscores how 2018 will be another extremely tough year for Woolworths. On Monday, it said group sales increased by 2.5% in the 26 weeks to December 24 2017, which failed to keep in line with SA’s inflation rate of between 4% and 5% over the same period.

One of its biggest problems is the South African fashion, beauty and home division, which saw sales decline by 0.2% while comparable store sales (excluding new stores opened) fell by 3.4%. Alec Abraham, a senior analyst at Sasfin Securities, said the division’s performance was worse than expected.

“I get the sense that most fashion retailers have been hit more by structural changes such as competition and promotional activity changes than cyclical changes like economic growth and low consumer confidence. Woolworths will have to be on top of its game as there is more competition,” said Abraham.

The division’s performance prompted one analyst to say management’s focus was largely on Australia while competitors The Foschini Group (TFG), H&M and Zara profited at its expense. TFG, Woolworths’ closest competitor, is accustomed to posting clothing sales growth (in Africa) of between 7% to 10%.

Another problem is the Australian operations. Comparable sales at David Jones and Country Road fell by 3.3% and 1% respectively. Woolworths’ push of its home-grown private label brands including Studio W and RE into David Jones stores flopped as the quality and fashionability of merchandise didn’t resonate with Australian shoppers.

A bright spot for Woolworths is the food segment, which continues to be a mainstay for the retailer.

Woolworths Food sales increased by 9.4% while comparable store sales grew by 5.3%. Stripping out its internal food inflation of 4.4%, sales volumes advanced by 5%.

Wayne McCurrie, the senior portfolio manager at Ashburton Investments, said falling food inflation in SA might slow Woolworths’ food profitability. “Falling inflation is going to make it difficult for Woolies to pass increases to consumers,” he said. Another threat is Shoprite’s plans to ramp up its exposure to higher-income consumers – a market traditionally conquered by Woolworths – through its Checkers brand.

Some market watchers have raised concerns about Woolworths’ debt position (gearing of more than 40% in 2017) if it continues to shed profits.  Its headline earnings per share is expected to fall between 12.6% and 17.5% and earnings per share will also be down by more than 20%.

Anthony Rocchi, portfolio manager at Rexsolom Invest, said Woolworths’ gearing levels are manageable as it’s a cash rather than credit-dependent retailer. “If the wheels had to come off properly it could cut back on capital expenditure and store expansion to shore up cash,” he said.

 

-Brought to you by Moneyweb 

 

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