Australia | Jun 24 2020
Woolworths has experienced an acceleration in food sales over recent weeks and is expected to exit the coronavirus crisis in a strong market position.
-Leverage is elusive because of cost growth
-Yet a substantial amount of costs likely to be temporary
-Return of capital unlikely until FY22
By Eva Brocklehurst
The ability of people to start gathering again has had a positive impact on supermarket food sales in recent weeks, Woolworths ((WOW)) asserts, while tobacco sales, or lack thereof, were a major drag. Liquor sales have benefited from ongoing restrictions on bars and clubs.
Woolworths expects FY20 underlying earnings (EBIT) to be $3.2-3.25bn. Sales were strong with the exception of hotels in the fourth quarter. Australian food sales rose 8.6%, NZ food sales 15.1%, Big W 27.8% and Endeavour Drinks 21.4%.
Shaw and Partners is positive on the outlook, believing the major supermarkets are better placed than most retailers in the current environment, with an effective market duopoly. Yet leverage is elusive, Morgan Stanley notes, given the cost growth. Specifically, earnings guidance implies broadly flat full-year earnings despite the strong growth in the first half.
Citi suggests sales are "excellent" although acknowledges operating leverage is relatively low, while UBS was also disappointed by the lack of operating leverage. Most of these costs should reverse through FY21, nevertheless, and the broker expects 7-9% earnings growth ex hotels.
UBS believes Woolworths is well-placed to exit the pandemic as a higher-returning business, assessing one or two quarters of heightened sales and costs are not material to valuing a listed grocer.
Moreover, there is an opportunity to expand the company's share of customer expenditure over the longer term. The broker concedes there is unlikely to be a significant re-rating story for Woolworths but there remains scope for an expansion of multiples.
Credit Suisse expects FY21 profit will be supported by above-trend growth in supermarket sales amid a normalising cost base and improvement in Big W and hotels. The broker suggests Big W was an under-appreciated positive aspect of the update because of the increasing likelihood of profitability, which will increase options for reinvestment and disposal.
A substantial amount of costs are expected to be temporary amid expectations that hygiene and social distancing costs will continue into July and then be progressively reduced as the health risks reduce.
Goldman Sachs notes guidance for an increase in pandemic-related operating costs has been maintained at $220-270m, albeit seen tracking at the higher end of this range. Management has indicated this guidance excludes team member bonuses, which the broker calculates at $125m.
Increased online transactions, particularly deliveries, along with losses in city-based metro stores have adversely affected Australian food earnings in FY20. As a result, underlying margins in the second half, in the broker's calculations, are likely to be down around -40 basis points for the Australian food and NZ supermarkets divisions and down -10 basis points for Endeavor Drinks.
Morgan Stanley now assumes a second half earnings margin of 4.37% in the Australian food business, down -34 basis points.
Macquarie anticipates recent losses of market share will unwind over the next year as conditions normalise. The broker points out shopping locally, which increased significantly during the height of the pandemic, has eased back.
Shaw expects Woolworths will maintain like-for-like sales growth above 3% and is better placed than its rival Coles ((COL)), given an ability to hold earnings margins at a higher level amid a significant packaging cost advantage and superior in-store execution.
Hotels have begun to reopen but around two thirds of the company's venues are in Victoria and Queensland where conditions are more restricted, particular for gambling. Management expects hotels to continue to be loss-making until more venues are operating with a full service.
Woolworths has advised separation of the hotels business is unlikely to take place before the first half of FY22 and Credit Suisse expects a return of capital is likely to wait until after that.
Woolworths will develop two automated distribution centres at Moorebank in NSW for an investment of $700-780m over four years. The investment will be funded through the existing capital expenditure framework. Construction is expected to be completed by the end of 2023 and initial benefits in FY25.