What would Woolies do with R10bn-plus from David Jones sale?

And should it even be trying to offload the retailer now?
One option is a special dividend to appease shareholders, some of whom would’ve suffered since 2014. Image: Jack Atley/Bloomberg

It is perhaps telling that in its most recent results presentation, Woolworths provided no real detail on the future of its Australian headache David Jones.

We can assume then, certainly backed by the fervent denials, that there is some credence to the rather loud murmurs in the Aussie financial press that Woolworths’s David Jones is for sale.

The retailer has ostensibly sounded out “investment and merchant banks” in an effort to offload the underperforming Australian department store.

Read: EXCLUSIVE: Exit Aus and list Woolworths Food separately, say top retail analysts

In a written statement to various media, Woolworths said it does not comment on “media or market speculation”. It added that Woolworths Holdings “remains focused on the operational turnaround of David Jones and ensuring that this iconic business is restored to its rightful market leadership position in Australia”.

But we’ve been here before.

The story of Woolworths and David Jones

The pursuit of David Jones by Woolies was widely reported before the disastrous purchase was sealed in August 2014.

The group bought the department store for R21.4 billion (Au$2.1 billion) in 2014 as part of a grandiose strategy to build a leading southern hemisphere retailer. It has since written the value of David Jones down by more than Au$1 billion to Au$965 million (or R10.7 billion, nearly half of the purchase price at current exchange rates).

So, at book value, ‘DJ’ as our friends down under call it, is worth upwards of R10 billion, probably.

The steps leading up to this presumed decision to try and sell the underperforming unit have, in hindsight, been clear.

Following the ruinous merger of the Country Road Group and David Jones head offices in Melbourne into a single structure, and after five CEOs for DJ in six years, Woolworths said that “value creation in Australia provides upside optionality in the case of both David Jones and Country Road Group, with each business now able to pursue its respective strategic ambitions”.

In other words, former CEO Ian Moir’s grand vision had collapsed into a heap. And it wasn’t Covid-19’s fault.

Read:

The group was candid in its most recent annual report, saying: “David Jones has disappointed for some time, having failed to deliver on the envisaged synergies and benefits post acquisition, despite significant investment.”

It added: “It is critical to implement a refreshed product and brand strategy, as well as rationalise the DJ Food offering to stem the losses from this part of the business.

“The most pivotal lever, however, to improving DJ’s underlying profitability, is a meaningful reduction in its rental cost to sales ratio; while negotiations with landlords are ongoing, they remain complex and challenging.”

One assumes there is at least some quiet progress on the rental front, ahead of any possible sale.

Time to sell?

It is almost exactly the right time to try and sell the business, given the return to profitability after the brutal impact of the Covid-19 pandemic as well as some clear own-goals including trying to replicate the Woolies Food business in a market that did not expect or want this from a department store.

That diversion cost many hundreds of millions of rands, likely more.

Operating margins are back to above 3% – roughly half the level they were when Woolies bought the business. At least it’s not making a loss as it did in 2020, and the Aussie debt has been repaid. Plus, there is presumably a clear course in place that gets these closer to 7%.

The hard work (and the easy stuff such as sale-and-leaseback agreements) has been done – aside from those onerous leases, of course.

The key here is whether group CEO Roy Bagattini and the board see much upside in DJ.

In truth, there can’t be. Its margin – even at 7% – is dragging down the group, where even its underperforming FBH (fashion, beauty, home) unit in South Africa reported a margin of 11.6% for the six months to end-December. This is far below levels it enjoyed before some major missteps in (particularly women’s) fashion. Country Road has historically enjoyed margins far higher than 7%. In the last six months, the group’s local food business has margins of 7.2%, which was last reached by David Jones in FY2016. That’s how bad the DJ deal was.

So it will likely achieve a price ‘reasonably’ above R10 billion for a business it no longer wants to own. Will it get close to the R21.4 billion paid? No chance. The closing won’t even be close to halfway between the two.

What to do with all the boodle?

The problem is that Woolies is then going to be flush with cash after destroying over R10 billion in shareholder value, arguably significantly more if one quantifies all the ‘unnecessary’ investment in DJ over the last seven-plus years.

It’s long been more than rumoured that local shareholders aren’t exactly enamoured with the value destruction prior to Bagattini arriving.

Shareholders applied for more than 100% of shares in the rights offer to fund the David Jones purchase – that’s how much they believed the story.

The billion-rand question is what use the board will have for a large amount of money that it honestly has no need for. The FBH and Food businesses in South Africa as well as Country Road Group are performing well.

Sure, it could squash R6 billion in borrowings in the local business but it will then no doubt be criticised by analysts and shareholders for being too conservative.

The easy answer is a special dividend to appease the unhappy institutional and retail shareholders, some of which would have suffered since 2014.

Could it really pay out a R10 special dividend per share (effectively all of the proceeds of the sale)?

That is wholly unlikely.

What if Bagattini has a card up his sleeve at a far more moderate level – one that doesn’t and can’t drag the company down?

Something like Pepkor’s purchase of Grupo Avenida in Brazil for less than R3.2 billion, or less than 4% of its market value (versus DJ, which was nearly 40% of WHL’s market cap when the deal closed).

The considerable problem for Bagattini is that with the food business facing stiff competition and the fixing of the FBH unit probably well on its way, there are precious few growth levers left.

Will shareholders tolerate that result?

Woolies share price

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cyncical me :

First the board would pay themselves and the hired help a huge bonus for unlocking the R10b.

Second, if there is anything left, they will rush out and buy another foreign folley – it’s the easiest way to get foreign passports for the hired help after all.

Exactly … I buy their food but I sold my stock.

Why are so few willing to recommend a reversion to, and R10bn capital investment in, the legacy format of Woolies (Good Food and Plain Clothing) – even exporting the franchise? The craving for fashion and an Australian domicile have been disastrous board decisions for SA investors.

End of comments.

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