Woolworths reported a 65% slump in earnings for the 52 weeks to end June 2020 on Thursday morning – yet by lunchtime the share price had edged up almost 3% to R34.77 and by close of trade it was up 6.57% to R36.
It’s difficult to imagine how bad things would have had to be to prompt a drop in the share price.
The slight recovery in the share price – it’s still way off the R60 it touched last November – may have been because the Covid-induced share price drop had been overdone or because the market really does want to believe the Woolworths recovery story.
This slightly jaded three-year-old story was reinvigorated during financial 2020 by the arrival of a new CEO and, crucially, the group’s much-improved cash flow. It’s inevitable the two are linked.
With the very notable exception of its South African food business, 2020 was a grim operational year for Woolworths; and it wasn’t just Covid.
Certainly the Covid lockdown in South Africa and Australia did significant damage – new CEO Roy Bagattini estimates it cost the group R2 billion – but it doesn’t explain the extent of the collapse in operating margins across the group (again, with the exception of Woolworths Food which bumped up operating margin to 7.7% from 7.2% in 2019).
At Fashion, Beauty and Home the operating margin slumped to 7.6% from 12.1%; Australia-based David Jones managed to cut its already wafer thin 2019 margin of 1.7% to 1.1%, turning in a loss before interest and tax; while at Country Road, also Australia-based, management looked on as operating margins slumped to 6.5% from 9.2%.
Failure to entice
While the actual operations looked grim with the wrong product, wrong price or wrong format failing to entice sufficient customers, it was down to work on the balance sheet to inject some verve into management’s jaded recovery story.
Cutting out the second-half dividend was probably the easy part, given that Covid-traumatised shareholders were braced for exceptionally bad news.
“The good news is the much stronger cash flow,” says Sasfin’s Alec Abraham, who believes that the new pair of eyes looking at the business has had a significant and positive impact. Abraham says that while operating margins were significantly below his expectations there has been considerably better-than-expected improvement in the balance sheet.
Removal of costs across the group, inventory reductions and extended supplier and other payment terms helped to beef up cash flow from operations and release R1.6 billion working capital. The sale of David Jones properties, which is an ongoing strategy, also helped.
The balance sheet is expected to continue to improve, with plans to cut back on trading space going beyond David Jones.
Abraham says there are also plans to pull back on floor space in SA.
He describes this as a breath of fresh air, given how much space was wasted in management’s devotion to a seemingly unwieldy product range. Plans to reduce capex to R1 billion will also help.
Bagattini says the balance sheet was a priority for him in 2020. Management has set a target of 1.5 times net debt to Ebitda (earnings before interest, tax, depreciation and amortisation) from the current two times. Press Bagattini on timing for achieving that target and he points out that the current environment makes forecasting problematic. Then adds: “Within the next 12 to 18 months.”
The new CEO denies that the only reason he hasn’t sold the struggling and value-destroying Australian businesses, which are self-funding, is because there is no buyer.
“I don’t have any sentimental commitment to the businesses, I’m trying to unlock value.”
He believes they present a viable proposition but realising it will involve a lot more squeezing. “We’ve got to ensure the juice is worth all that squeezing,” says Bagattini.
Ironically the Covid-19 crisis has helped with the squeezing as it has made landlords more willing to engage.
Bagattini is looking to reduce David Jones trading space by 20% within two years. He would like to see leases become variable components of the business. But it’s not just the cost base, improving the way they trade will also be an ongoing challenge.
Local customers set to be heard
On the local front the Fashion, Beauty and Home division is likely to feel the pressure of some squeezing.
“We took our eye off the customer and didn’t leverage the data we were getting from them,” says Bagattini, who talks of “lots of stuff being thrown out to see how it would work”. Not very well it seems, given discounting that had to be done to clear stock.
Abraham says the commitment to investing R750 million in cutting prices in the Food division reflects the group’s determination to grow its market share by shifting consumers’ perception of high prices.
Bagattini, who stepped into the hot seat just weeks before the pandemic made an already tough job potentially insurmountable, told analysts on Thursday that there were tough decisions to be made, but assured them:
“Nothing is insurmountable.”
He told Moneyweb that shareholders would see evidence of the group’s “refreshed strategy” by this time next year.
But Abraham cautions that financial 2021 is likely to see another drop in earnings – albeit a much more modest single-digit figure. He is however expecting a strong pick up in financial 2022 if the refreshed strategy stays on track.
Listen: Woolworths CEO Roy Bagattini discusses the group’s results for the 52 weeks to June 2020.