Woolworths: Giving back some gains

Author name:: By Alex Lu
Job title:: Analyst
Date posted:: 07 November 2022, 7:30 AM
Sectors Covered:: Industrials

Woolworths' (ASX:WOW) 1Q23 sales trading update overall was weaker than we expected.
LFL sales: Australian Food -1.1% (vs MorgansF +0.2%), NZ Food -3.3% (vs MorgansF -0.5%) and BIG W +29.9% (vs MorgansF +25.0%).
Management said year on year sales growth trends in Australian Food have improved in October as the business cycles out of the NSW and VIC lockdowns of last year, with the 3-year sales growth rate broadly in line with 1Q23.
WOW also provided guidance for 1H23 NZ Food EBIT of NZ$100-130m, implying a decline of 40% at the midpoint vs the pcp.
We decrease FY23-25F group underlying EBIT by 1%.
Our target price decreases to (login to view) and we maintain our Hold rating. Trading on 23.5x FY23F PE and 3.1% yield we continue to see the stock as fully valued and continue to prefer Coles (ASX:COL) in the Staples sector.

Australian Food sales were below expectations

Australian Food like-for-like (LFL) sales fell 1.1%, which was weaker than our +0.2% forecast and COL’s Supermarkets growth of 2.1%. Sales growth was impacted by a decline in items (LFL -8.6%) following elevated demand in the pcp due to lockdowns in NSW and VIC as well as supply challenges in fruit & vegetables this year. This was partly offset by higher shelf prices.

Average food prices increased 7.3% (or 6.8% ex-tobacco and fresh) compared to the pcp, which was similar to COL’s Supermarkets inflation of 7.1% (or 6.7% ex-tobacco and fresh). In Fresh, inflation was driven by double-digit inflation in fruit and vegetables (inclement weather) as well red meat (higher commodity prices) and dairy (higher milk farm gate prices).

In Packaged, inflation was mainly driven by higher supplier cost price increases due to input cost pressures.

Online sales fell 10.8% as customers returned to shopping in store. A return to more normal trading conditions and increased customer mobility resulted in online penetration decreasing to 10.2% vs 11.4% in the pcp.

NZ Food EBIT expected to be down ~40% in 1H23

NZ Food LFL sales declined 3.3%, which was softer than our -0.5% forecast. Growth was impacted by the cycling of the Delta outbreak from mid-August last year with customers purchasing fewer items. Despite the decline in sales, online sales rose 5.9% with penetration now at 14.2% (vs 13.1% in the pcp), suggesting the weakness has been felt more in stores.

WOW has provided guidance for 1H23 NZ Food EBIT of between NZ$100-130m (implying a 40% decline at the midpoint vs the pcp) due to higher costs and supply chain investments. With guidance already in line with our previous estimate of NZ$123m, we make only a minor adjustment to our forecast (now NZ$122m).

Outlook

WOW said year on year sales growth trends in Australian Food have improved in October as the business cycles out of the NSW and VIC lockdowns of last year, with the 3-year sales growth rate broadly in line with 1Q23.

The company is continuing to see early signs of customer purchasing habits changing, although it was unclear how much of this is related to cost-of-living pressures compared to COVID normalisation.

Overall, we forecast Australian Food LFL sales to be up 4.1% in 2Q23.

Changes to earnings forecasts and investment view

We make modest adjustments to earnings forecasts with FY23-25F group underlying EBIT decreasing by 1%.

Our PE-based target price falls to (login to view) on a lower valuation multiple of 25x (vs 27x previously) reflecting the recent decline in sector multiples and the uncertain cost environment.

Hold rating maintained.

Risks

Upside risks include faster-than-expected Australian Food sales growth, lower costs and higher margins.

Downside risks include increased pricing intensity, more competitors entering the supermarket sector and a slowdown in sales momentum. Staff shortages, supply chain constraints and weather are also risks.

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