Company Reports

A challenging trading environment took its toll on narrow-moat Woolworths in fiscal 2024. Group earnings declined 1% on the previous corresponding period, or PCP. Fiscal 2024 net profit after tax of AUD 1.7 billion was in line with our estimate, and our earnings forecasts are mostly unchanged. We lift our fair value estimate by 4% to AUD 28.50, largely reflecting the time value of money. Shares screen as overvalued. We believe a P/E of 26 at current prices and based on our fiscal 2025 earnings estimate is too expensive for a relatively low-growth, defensive yield stock. We forecast a five-year EPS CAGR of 5%.

Woolworths is one of Australia's largest retailing groups, operating supermarkets and discount department stores. Its market capitalization is around AUD 45 billion, with annual sales of around AUD 70 billion.

The upcoming August 2024 reporting season will draw the line under a difficult year for Australian retailers in which they navigated soft demand and soaring labor costs. The combination results in a profit margin crunch and declining earnings for many retailers.

Woolworths' March quarter 2024 update reveals that, like competitor no-moat Coles, its customers are under pressure. Australian supermarket sales grew a modest 1.5% on the previous corresponding period, starkly underperforming 5% growth at Coles. We are reluctant to extrapolate the differential in sales growth of the two largest Australian supermarket chains over a relatively short time period. There are temporary factors for divergence in near-term sales momentum, including the timing of promotions and Coles' collectibles marketing.

Talk of interest rate cuts and impending tax cuts is sparking a rally in consumer cyclicals. We agree these factors improve the near-term outlook for consumer spending, with cyclical retailers more exposed. We expect the combined impact of fiscal and monetary tailwinds to underpin mid-single-digit growth in total retailing sales in the medium term—compared with our estimate of only 2% growth in fiscal 2024. But underlying our near-term forecast is a significant divergence across categories, with sales in cyclicals virtually flat and defensives up 4%.

Woolworths is one of Australia's largest retailing groups, operating supermarkets and discount department stores. Its market capitalization is around AUD 45 billion, with annual sales of over AUD 60 billion.

Narrow-moat Woolworths’ first-half fiscal 2024 EBIT of AUD 1.69 billion was within the guidance range from late January 2024. The core Australian supermarkets business' solid performance largely offset lower profits from its struggling New Zealand and discount department store segments. Sales momentum deteriorated across all retailing businesses in the first seven weeks of the second half. Against a backdrop of higher wages, we expect near-term operating margins to be under pressure.

The noncash goodwill write-down of Woolworths’ small New Zealand business has no direct impact on our AUD 27.50 per share fair value estimate for the group, nor our underlying earnings estimates. However, the turnaround of the New Zealand business is likely to take longer, with management citing a weaker medium-term market outlook as a reason for the impairment. We’ve reduced our group earnings estimates by an average of 1% over the next decade to fiscal 2033 and the New Zealand segment represents a mere 11% of group operating earnings over the period.

E-commerce platforms have been outperforming physical stores recently. Transaction data from National Australia Bank suggests online retail sales in October lifted 10% on last year, while total retail trade was up only 1%, as reported by the Australian Bureau of Statistics.

We maintain our fair value estimate of AUD 27.50 for shares in narrow-moat-rated Woolworths. With the revenue tailwind of food price inflation abating, the task of driving top-line sales growth in the core Australian supermarket segment is now more reliant on food sales volumes. We expect Australian wage inflation of 6% to outstrip food sales growth of around 5%, weighing on the segment’s operating profit margins in fiscal 2024. Strong growth in less profitable online sales could be a further headwind to near-term margins.

We expect only modest discretionary goods sales growth in fiscal 2024, while interest rates stay high and household incomes struggle to keep up with inflation. With demand soft, discounts and promotions abound in discretionary retail, and with wages rising as well, earnings are under pressure. But for some, cost pressures are easing. Steep declines in global food commodity prices bode well for fast-food restaurants. Quick service restaurant operator no-moat Collins Foods and master franchisee narrow-moat Domino’s Pizza screen as undervalued.

We increase our fair value estimate on narrow-moat Woolworths by 2% to AUD 27.50 after revising our longer-term estimates. Higher maintainable operating margins in the Australian food segment and the time value of money both contribute but higher long-term capital expenditures detract. Fiscal 2023 underlying NPAT of AUD 1.721 billion was in line with our forecast. The group’s core Australian supermarkets—generating close to 90% of operating earnings—beat our expectations, offsetting weaker results from New Zealand Food and discount department store Big W.

Narrow-moat Woolworths’ first-half fiscal 2023 sales growth of 4% and 16% increase in underlying EPS were ahead of our expectations. We increase our fair value estimate by 2% to AUD 27 per share, due to a now slightly greater sales base for the core Australian food segment, which accounts for over 80% of group earnings. We increase our fiscal 2023 adjusted EPS estimate by 4% to AUD 1.41.

Inflation in costs and shelf prices, more out-of-home food consumption and declining sales volume, evaporating COVID-19 expenses—these are the three key challenges and opportunities we see for Australian supermarket operators in fiscal 2023. We expect the combination of these themes to result in relatively weak sales growth and a slight decline in operating margins for Woolworths and Coles. However, we expect the trading environment in Australian food industry to have normalised by fiscal 2024 and Woolworths and Coles to increase operating earnings around 4% per year for the remainder of the decade.

We recommend shareholders in narrow-moat Woolworths Group vote in favour of the proposed demerger of Endeavour Group at the General Meeting to be held on June 18, 2021. Subject to shareholder approval, Woolworths shareholders will receive shares in Endeavour Group and maintain their ownership in both businesses upon demerger. We intend to initiate coverage on Endeavour Group prior to the commencement of trading on the ASX on June 24, 2021.

Woolworths is Australia's largest major retailer, operating supermarkets and discount department stores. Market capitalisation is around AUD 50 billion, with annual sales of over AUD 60 billion.

Woolworths is Australia's largest major retailer, operating supermarkets and discount department stores. Market capitalisation is around AUD 50 billion, with annual sales of over AUD 60 billion.

Woolworths is Australia's largest major retailer, operating supermarkets and discount department stores. Market capitalisation is around AUD 50 billion, with annual sales of over AUD 60 billion.

Woolworths is Australia's largest major retailer, operating supermarkets and discount department stores. Market capitalisation is around AUD 50 billion, with annual sales of over AUD 60 billion.

The partnership with online grocery sales specialist and service provider Ocado provides no-moat-rated Coles access to state-of-the-art end-to-end online technology and increases the pressure on Woolworths. However, Coles gives up some of its future online channel earnings in return and we surmise it must also deliver on growth and market share targets to remain Ocado’s exclusive partner in Australia. We expect any material operating margin improvements to be passed on to consumers to compete with peer Woolworths, but also the discounting channel, including Aldi. We maintain our AUD 12.30 fair value estimate on Coles and shares offer little margin of safety at current prices.