SA’s retail rock star

Woolworths CEO Ian Moir delivers first tranche of post-acquisition returns.

“I’ve always said, retailing is not rocket science. If you focus on your customer, and deliver the right products at the right price, you will see the returns,” says Woolworths CEO Ian Moir.

And so it was that in the eleven months that Woolworths has owned David Jones, it reported the strongest sales growth in almost a decade. Comparable sales at the iconic Australian retailer were negative in the first half of the year, but increased by 6.5% in the second half to grow by 3.7% over the full period.

As a result David Jones halted an earnings slide that at one stage threatened the very existence of the group. Operating profit rose 28.8% to A$161 million.

David Jones now constitutes a hefty 28% of Woolworths turnover for the year ended June 28, 2015. 

“This year has been transformational for our group with the acquisition of David Jones and the full ownership of Country Road Group enabling us to make a step change in the scale of our operations: transforming it into a quality retailer with significant scale across sub-Saharan Africa and Australasia,” says Moir.

Group sales (including concession sales) increased by 54.9% to R62 billion, and by 12.0% excluding David Jones. Adjusted profit before tax increased by 20.5% and adjusted headline earnings increased by 24.3%. Adjusted headline earnings per share grew by 10.4%. 

The acquisition came with a hefty R23.2 billion price tag and the number of shares in issue increased by 22.5%. “When you look at the adjusted headline earnings number against the number of shares in issue, the net effect is neutral,” says Cassie Treurnicht, investment analyst at Gryphon Asset Management.

“David Jones has performed well, but I get the feeling that there is still a lot of work that needs to be done to realise the targeted synergies that have been promised. I believe we will see these coming through over the next few years.”

Locally, the Woolworths food business, which has grown ahead of the market every month since September 2011, reflected sales growth of 13.5% on price movement of 7.7%. The gross profit margin increased to 25.7%. Operating profit was up 25% to R1.5 billion.

“This was a surprise,” says Old Mutual Equities analyst Meryl Pick. “With competition from the likes of Pick n Pay and a stressed consumer I had expected to see margins under pressure. Instead they have improved, demonstrating the food strategy is working.”

The strategy that needs refining lies within Woolworths Clothing. The division disappointed with sales growth of 9.6% and 4.0% in comparable stores (including Country Road in South Africa). Operating profit for Clothing and General Merchandise grew by 3.3% to R2.1 billion.

A disappointing performance from kids clothing and footwear – where price inflation appeared to get out of control – was partly to blame.

“Woolworths Clothing has had a patchy track record,” says Pick, “with sales growth that constantly lags that of their competitors.” However, new head Christo Claassen (former head of Legit, Jetmart, Jet and the cellular division at Edcon), is determined to shake things up a bit. “He has a firm focus on value,” says Pick, “in the same way that Foods ensures its prices of branded items are competitive, Christo is focused on ensuring core items are competitively priced – your kids chinos cannot be more expensive than those of your competitors.”

The Country Road brand has been rolled out into David Jones’ 38 stores and Woolworths’ private label brands – Studio.W, RE:, JTOne and Distraction – were introduced into several stores last week.

“This will be a good test for these brands,” says Pick. “Australian consumers do not know these brands and their response will undoubtedly be fed back into the South African business. It could catalyse some positive changes in the non-Country Road clothing offering.”

Woolworths Financial Services grew net interest income by 15.5% resulting in a 21.9% increase in profit before tax. The debtors book grew 10.7% and the impairment rate was kept at an industry-leading level of 5.4%.

The outlook for the year ahead remains muted. “We believe that economic conditions in South Africa and Australia will remain constrained, although the upper income segments in which we operate continue to show some resilience,” says Moir. “We continue to trade ahead of the market and trading for the first eight weeks of the new financial year has been positive.”

Woolworths paid a full price for David Jones and management will have its hands full extracting the efficiencies and capitalising on the opportunities that they have promised, says Treurnicht. “Investors might’ve also thought that the Australian dollar would give it a bit of a rand hedge, but with turmoil in commodities the rand has actually strengthened vs the AUD since the acquisition was made.”

That said, Sasha Naryshkine and the team at Vestact, believe that despite the fact that Woolworths is trading off a 27x PE, the stock is attractive. “This is a really good business with a really sharp management team. You always get what you pay for. As with a company that is likely to grow their earnings in the mid teens for the next couple of years, we continue to be happy to pay up for the quality of the business. It has a strong dividend policy too.”

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27 PE for mid teen growth is not a value proposition. And with their keen dividend policy of 1.4x cover their yield is just over 2.5%. This is after years of margin expansion. I’m not sure how analysts come up with their conclusions nowadays, I think this market has seriously dumbed down as a result of central planning.

No wonder Woolies is top of the pile. In my opinion, their fruits, vegetables and meats are of high-quality compared to say Pick n’ Pay, whose fresh-food offerings are sub-standard by contrast. And their prices are competitive with other retailers. Their stores are clean and pin-neat, easy to get around and their staff are friendly, informative and helpful. And one doesn’t have to wait long at checkout – a real problem with other retailers in South Africa.

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