Company Overview - Woolworths Limited is a retail company. The Company's segments include Australian Food and Liquor, which includes procurement of food, liquor and petroleum products, through the brands Dan Murphy's and BWS; New Zealand Supermarkets, which includes procurement of food and liquor products, through approximately 200 Countdown Supermarkets; General Merchandise, which includes procurement of discount general merchandise products, through the brands BIG W and EziBuy; Hotels, which is engaged in the provision of leisure and hospitality services, including food and alcohol, accommodation, entertainment and gaming, and Home Improvement, which includes procurement of home improvement products. It operates over 3,700 stores across Australia and New Zealand, which span food, liquor, petrol, general merchandise, home improvement and hotels. It also operates Cellarmasters, Langtons and winemarket.com.au online platforms. Its brands include Woolworths Supermarkets, Countdown and Thomas Dux.


WOW Details

Third quarter performance highlights: Woolworths Limited (ASX: WOW) core segment, Australian Food and Liquor sales reached $10.7 billion, which is a rise by 0.4% for the third quarter of 2016 as compared to the same period of last year. But, the segment’s Easter adjusted comparable sales fell by 0.9% during the third quarter against prior corresponding period (pcp). New Zealand Supermarkets revenues during the third quarter reached NZ$1.6 billion, which is a rise by 3.8% against pcp but witnessed a 0.1% fall in Australian dollar terms. However, the segment’s Easter adjusted comparable sales improved by 0.6% during the quarter against pcp. On the other hand, General Merchandise sales fell by 4.6% to $865 million against pcp while Easter adjusted comparable sales lost 4.5%. As per Hotel segment, the sales rose by 2.5% to $368 million, during the third quarter as compared to pcp while Easter adjusted comparable sales surged by 0.7%
 

Third quarter sales results for 13 weeks to April 03, 2016 (Source: Company reports)
 
Seeking a new phase of its Liquor business:Woolworths Ltd has renamed its Woolworths Liquor to Endeavour Drinks Group, which would take effect from June 01, 2016. The liquor has been a strong performer over past few years and the management expects revenues of over $ 8 billion in FY16 after reporting $4.4 billion in the first half of FY16 recording growth of 4.9%. Moreover, as per Roy Morgan Research (as of November 2015) BWS brand has 17.9% market share after Dan Murphy’s dominating market share of 26.3%. Meanwhile, during the third quarter of 2016, management reported that Dan Murphy’s witnessed a solid Net Promoter Score in March 2016 despite facing rising price competition in the market from wine. Even, BWS continued to deliver strong comparable store growth during the quarter. The group opened one (net) Dan Murphy’s leading to the total to 205 while BWS decreased by two (net) stores leading the total to 1,265 (including both standalone and supermarket attached BWS stores).


New Stores and Renewals/ Refurbishments (Source: Company Reports)
 
Challenges despite growth efforts:Big W is struggling to remain relevant while the major threat to this brand is that the product they sell could be obtained from a multitude of sources.  On the other side, there are structural changes occurring in the grocery-shopping segment. This move towards online shopping and home delivery of fast moving consumer goods, fresh and perishable product is a major threat for the established retailers like Woolworths. WOW also has a net repayable debt of $3.1 billion as per its half yearly of 2016 report. The group’s credit quality is facing pressure as in the month of May, Standard and Poor’s have downgraded from BBB+ to BBB for the group’s senior unsecured notes while Moody’s have retained the rating as Baa2 (outlook negative).
 
Focusing on expansion and undertaking various initiatives towards transition: Woolworths is focusing more on expanding its number of stores rather than increasing sales at existing stores. But, the group’s competitor, Coles, has overtaken Woolworths on same store sales growth over the past 27 quarters. As a result, Woolworth has been under pressure to slash its margin during the period while Coles reported a rise in profit margins. However, Woolworths still has Lion’s market share. The group’s new management has taken various steps to bring turnaround in the business. The management is confident that they would rebuild Woolworths’ supermarkets in next three to five years. Among all, the important initiative is to have customer focus on delivering better prices and improved services. The company is investing an additional $150 million in second half of FY16 on price, services and loyalty in supermarket. It has new operating model designed to reduce costs, increase business accountability and improve shared service delivery effectiveness. The management is confident to restore sales momentum in next three to five years and would invest to be the first choice of customers. While announcing these initiatives, the management has guided a small loss in FY16 in General Merchandise due to clearance of existing stocks. The group’s new operating model efforts include a lean corporate center which would undertake its structure, policies and procedures. Moreover, the group’s external reporting Portfolio businesses which comprise segments like BIG W, ALH, Home Improvement and Quantium would have separate governance as well as would be managed by separate subsidiary / joint venture boards. Management is also implementing a changed approach to shared services as well as undertaking cross-business transformation initiatives to ensure smooth businesses.
 

Average Price Changes (Source: Company Reports)
 
Divesting non-core business to improve focus on core business:Woolworths has earlier announced its exit of Home Improvement, and recently reported that they are progressing according to the mechanisms set out as per the Hydrox joint venture agreement. The group announced sales of its hardware business – Masters in January after a strategic view that it needs more investment to bring it to profits. A sale of Master business at a decent price would be positive for Woolworths. Moreover, the group also informed that, Lowe’s expressed their supports for the sale of the businesses of Hydrox in spite of the delay in finding the value for Lowe’s shares. As per the Home Improvement segment’s third quarter of 2016 performance, the sales rose over 11.4% to $507 million, as compared to the same period of last year while reported an 11.9% increase on an Easter adjusted basis. Masters reported an outstanding performance during the third quarter of 2016 which rose by 30% on yoy basis to $282 million, while delivered a 28.8% rise on an Easter adjusted basis. But, Home Timber and Hardware sales fell by 5.5% to $225 million, during the third quarter of 2016 as compared to pcp while declined by 3.8% on an Easter adjusted basis. As of third quarter of 2016, overall Masters and Home Timber and Hardware store numbers were maintained at 63 and 43, respectively.
 
Stock performance: The shares of WOW have been under pressure and fell over 21% in the last one year and lost over 8.6% during this year to date (as of May 27, 2016). This decline in the share price was mainly due to the group’s struggling margins in its core food and liquor division and ongoing struggles for discount variety store Big W. Rising competition from its peers like coles and online players have also hurt the stock’s sentiment. On the other hand, the group is investing on longer term growth and accordingly undertaking several initiatives to put the company back to the growth track down three to five years from now. The company’s largest shareholder, fund manager Perpetual Limited has also increased its holding to more than 5% on turnaround potential. The group’s FY16 performance might also see benefits from its cost saving initiatives and its investments on pricing might also lead to better sales growth across its business segments. Moreover, the company also has impressive dividend yield. WOW stock have recovered over 3.9% (as of May 27, 2016)in the last four weeks and we believe that the positive momentum in the stock would continue in the coming months. Assuming the various positives including that the new management would execute the transition successfully, we maintain our “Buy” at the current price of  $22.39
 

WOW Daily Chart (Source: Thomson Reuters)

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