Australia | Dec 16 2021
This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW
Brokers were caught out by the extent of covid ramifications to date in the first half and the level of cost increases hitting Woolworths’ bottom line. But there is some light at the end of the aisle.
-Woolworths shocks with its earnings update
-Cost increases everywhere
-Online investment ongoing
-Margins should improve into FY23
By Greg Peel
Supermarkets in general proved a lockdown winner in 2020, and again for NSW and Victoria in 2021, as consumers had little choice but to cook at home. Hence analysts were expecting Woolworths’ ((WOW)) pace of growth in grocery sales to ease off once restrictions were again lifted.
Lockdowns also encouraged an uptick in online grocery shopping, particularly in the “click & collect” option Woolworths was offering. The company continues to invest in its online business, assuming, no doubt correctly, that many shoppers will stick with this option post-covid. Online retailing in general has seen a huge covid-driven boost and there’s no going back.
Some retailers have responded by boosting their online capacity while reducing their bricks & mortar footprint. This is not an option for supermarkets. The shift to online shopping means a shift away from in-store shopping, which supermarkets still have to staff and supply. Online sales are lower margin compared to in-store sales, but Woolworths is pressing on with its online investment.
Management decided it could counter lower margins by increasing in-store efficiencies and staff productivity. At least that was the plan. What management didn’t anticipate, apart from delta, was that the restrictions on households that drove more grocery shopping also meant restriction issues for in-store staff.
Staff were required to be tested for delta every three days. Then they had to wait a day for the results. For a labour-intensive operation like a supermarket, the impact was significant. Efficiency and productivity plans went out the window.
Woolworths, like many other large retailers, also had to employ more security staff to monitor QR and mask compliance, and presumably to break up fights in the toilet paper aisle.
Such restrictions similarly impacted on the company’s distribution centres. This on top of supply shortages and delays caused by covid among suppliers. These led to a sharp increase in wholesale grocery prices, and the big rise in oil prices flowed through to transport costs.
Management knew they could not just pass on these prices rises immediately to retail prices, as consumers would simply abandon Woolies for the competition down the road.
But wait, there’s more.
Not helping in the equation was an increase in tobacco excise, and the fact it hosed down in the south-east all spring, leading to again lower in-store shopping. And store closures during lockdowns were always going to impact on Big W, but also more so than analysts feared.
In short, everywhere Woolies looked, it saw higher costs. But management was determined to push on with its online investment anyway, copping the short term earnings impact in exchange for investment in future earnings.
Suffice to say, the hit to Woolworths’ earnings in the first half to date was a lot more than analysts had expected. The rush was on to cut first half and full year forecasts. The market took a knife to the share price, leading to a -7.7% decline on the day of the trading update.
For an ASX top 20 company, and a supposed defensive plodder at that, this was carnage.
By contrast, the average target price set by the seven brokers in the FNArena database, dropped by only -2.7%, to $37.14 from $38.17. Brokers were in unison in outlining all the reasons for the earnings surprise, and they are also pretty much in unison in believing margins will bounce back by FY23.
Heading into the trading update, Woolworths was commanding a price/earnings premium over rivals Coles ((COL)) and Metcash ((MTS)). This informs why database brokers had among them two Sell ratings, four Holds and only one Buy (or equivalents). Post-update, no broker has changed its rating.
(Note: Morgan Stanley has not updated.)
Australian states, other than the People’s Democratic Republic of Western Australia, have now shifted to a “living with covid” model rather than the earlier “zero-covid” model. Yesterday was a milestone in NSW as restrictions on masks/QRs were dropped on the same day the non-vaccinated were allowed to crawl out into the light, and new cases hit over 1300.
The sun will come out tomorrow
With the unavoidable caveat of “unless some new evil variant emerges”, forcing lockdowns once more, analysts agree Woolworths’ cost problems will subside by the first half of FY23.
Supply shortages/delays and food inflation will continue into the second half FY22, before beginning to fade. Management should be able to quietly lift retail prices to match wholesale prices after Christmas, in the typically quieter period of January-February.
It will depend how omicron plays out, but the expectation is the impact on staff from testing and so forth will also eventually subside.
What won’t subside is management’s ongoing investment in online. The pace of online sales growth will likely ease somewhat in the second half post-lockdowns, but only to a level much higher than pre-pandemic. Efficiency/productivity plans should be able to be returned to but in the meantime, Woolworths will trade near term's lower earnings against future investment benefits.
Ord Minnett “continues to view online as an unprofitable channel in grocery,” yet remains the lone voice in the wilderness with its Accumulate rating. The big share price plunge on the day was sufficient.
Recalling that Woolies enjoyed a premium over rivals heading into the update, other brokers are unmoved in their negative views.
UBS (Sell) makes the additional point that supermarket sales naturally improve on population growth, and that has been zero in 2020-21.
Unless it is prompted by Woolworths’ revelations to issue its own update, Coles will not report on its December quarter sales until early next year. One presumes what impacts on Woolies must similarly impact on Coles, but Coles was trading on a lower valuation. Its shares fell only -2.7% in sympathy on the day.
Database brokers have four Buys, two Holds and one Sell on Coles.
Metcash shares actually rose 0.7%. Metcash reported first half FY21 earnings last week (April year-end) and also surprised brokers, but to the upside. Not only did IGA grocery sales hold up better than expected post-lockdowns, the hardware division smashed it out of the park and is now the leading source of Metcash earnings.
Database brokers have five Buys and one Hold on Metcash.
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