The reaction by the market yesterday to Woolworths’ profit result, which saw it add 48c to close at $35.68, was to be expected. It was a small ‘beat’ and certainly not as bad as some analysts had feared.
The company reported net profit (from continuing operations) of $795m for the half year, down 6.5% on the comparable period in FY21. Higher direct and indirect Covid related costs, material stock flow and supply chain issues, and BigW store closures impacted profitability. The Group was also navigating a comparable period (FY21) boom in supermarket sales.
Australian food sales, which account for 75% of group sales, were up by 3.4%, while NZ food sales were up by 8.3%. But BigW, which was impacted by omicron related store closures and a decline in foot traffic, saw sales plunge by 9.0%.
EBIT for BigW fell from $133m to just $25m. Australian food also saw a fall, from $1,317m to $1,217, as its cost of doing business increased by 140bps from 23.7% to 25.1%. An increase in gross margin (higher prices) meant that the decline in the EBIT to sales ratio was 61bps, landing the EBIT margin at 5.1%.
Competitor Coles kept its decline in EBIT margin to 10bp from 5.1% to 5.0%, with its cost of doing business only rising by 30bps to 21.1%.
On the sales front, Woolworths maintained its lead over Coles in the all-important “comparable store sales growth rate” category, although the gap is narrowing. In the most recent (Christmas) quarter, Woolworths grew sales by 1.9% compared to growth at Coles of 1.6%.
Shareholders saw their dividend nominally decline from 53c to 39c per share, but adjusting for the demerger of the Endeavour Group, the effective reduction was 1c from 40c to 39c.
Looking ahead, CEO Brad Banducci said that after a strong Christmas performance, the group was “focussed on a more consistent operating rhythm in the second half”. Australian food sales had gotten off to a good start, up around 5% in the first 7 weeks of the year compared to the comparable period in FY21. Inflation is expected to continue to trend upwards with shelf prices already up 2% to 3% on the prior year.
BigW is still being impacted by omicron, with sales down 4% compared to the prior period, but it is expected to be profitable in the second half. Covid direct costs are falling and are expected to normalise over the half.
What do the brokers say?
Going into the result, the brokers saw Woolworths as somewhat expensive with a clear preference on valuation grounds for competitor Coles. The consensus target price was $36.85, about 3.3% higher than yesterday’s close of $35.68.
According to FN Arena, the range of target prices was from a low of $30.87 by Credit Suisse through to a high of $40.00 from Macquarie. As the following table shows, there was 1 ‘buy’ recommendation, 3 ‘neutral’ recommendations and 2 ‘sell’ recommendations.
Following the result, we are likely to see small upgrades to consensus earnings as Covid costs are coming down and goods inflation is not as bad as perhaps feared. Target prices may also rise by a modest amount.
Upgrades to earnings forecasts will help to lower Woolworth’s elevated multiples. It is currently trading on a multiple of 31.1 times forecast FY22 earnings and 26.2 times forecast FY23 earnings. Competitor Coles is on a multiple of 23.5 times forecast FY22 earnings and 21.5 times FY23 earnings – about 20% cheaper.
Bottom Line
Woolworths is the classic defensive stock. When the market is under pressure, it does relatively better. Conversely, if the market rallies, its gain can be more measured. There is nothing in this result that is going to change the market’s perception of Woolworths – so if the market rallies, Woolworths can go higher.
The other question is “Woolworths or Coles?”. This ultimately comes down to the size of the premium because market leaders trade at a premium. While Coles has narrowed the sales gap and net margin (EBIT to sales) gap, it faces some major investment hurdles with increasing capex required.
It is a line ball call, but because Coles has rallied strongly since its result was announced on Tuesday, my inclination is to stick with Woolworths. Further, experience tells me that if in doubt, go with the market leader.
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