Woolworths: Returning to a stable operating rhythm

About the author:

Author name:

By Alex Lu

Job title:

Analyst

Date posted:

23 February 2023, 8:00 AM

Sectors Covered:

Industrials

• Woolworths’ (ASX:WOW) 1H23 result was ahead of expectations.
• Key positives: All divisions except BIG W delivered EBIT that was ahead of our forecasts; Group EBIT margin rose 60bp to 4.9%; Operating cash flow jumped 24%.
• Key negatives: eCommerce sales fell 8% with penetration decreasing to 9.7% vs 10.8% in the pcp as customers returned to shopping in store; NZ Food EBIT margin was down 200bp to 3.0% due to significant cost inflation.
• Management said the company has had a strong start to 2H23 with operating conditions continuing to stabilise and sales growth robust.
• We adjust FY23/24/25F underlying EBIT by +1%/+1%/+1%.
• Our target price rises to (login to view) on the back of the earnings changes and a roll forward of our model to FY24 forecasts. Hold rating maintained.

Very good 1H23 result

1H23 EBIT jumped 18% to $1,637m (+2% vs MorgansF and +5% vs Visible Alpha consensus) and underlying NPAT increased 14% to $907m (+1% vs MorgansF and +3% vs Visible Alpha consensus).

All divisions except BIG W delivered EBIT above our forecasts: Australian Food +18% (+4% vs MorgansF); Australian B2B +111% (+26% vs MorgansF); New Zealand Food -42% (+1% vs MorgansF); and BIG W +436% (-10% vs MorgansF).

Australian Food cycles significant COVID costs in the pcp

Australian Food EBIT increased 18% to $1,439m on the back of 3% sales growth as customers returned to shopping in store. EBIT margin rose 80bp to 5.9%, which benefitted mainly from the cycling of $161m of direct COVID costs in the pcp despite higher labour costs, new stores and further investment in digital capabilities.

Excluding direct COVID costs in the pcp, EBIT increased 4%. Food inflation was 7.7% in 2Q23 vs 7.3% in 1Q23.

In fresh, price increases were evident in poultry and dairy products while fruit and vegetable inflation moderated somewhat during the half as supply conditions improved. Long-life inflation was driven by supplier cost price increases.

NZ Food’s earnings were down but within management’s guidance range

NZ Food’s performance was weak with EBIT falling 39% to NZ$122m. The result was marginally ahead (+1%) of our forecast and within management’s guidance of between NZ$100-130m provided at the 1Q23 sales trading update in November.

Sales increased 1% despite cycling elevated demand in the pcp due to lockdowns but earnings were impacted by significantly higher labour costs and delayed efficiency initiatives.

Encouragingly, WOW expects productivity initiatives to regain momentum in 2H23 as operating rhythm improves and has maintained guidance for 2H23 EBIT to be above EBIT in 1H23 and 2H22 (NZ$115m). For 2H23, we forecast NZ Food EBIT to be up 22% to NZ$141m.

Strong start to 2H23

Management said the company has had a strong start to 2H23 with operating conditions continuing to stabilise and sales growth robust.

For the first seven weeks of 2H23, Woolworths Food Retail sales were up 6.5%, NZ Food sales were 6.3% higher, and BIG W growth was strong at 9.7% as the business cycled the impact of Omicron in the prior year.

Despite the solid start, WOW said EBIT growth in 2H23 will be below 1H23 as the company cycles a more normal second half. For 2H23, we forecast group EBIT to be up 8% vs 18% growth in 1H23.

Changes to earnings forecasts and investment view

We adjust FY23/24/25F underlying EBIT by +1%/+1%/+1%.

Our PE-based target price rises to (login to view) on the back of the earnings changes and a roll forward of our model to FY24 forecasts.

While we retain our Hold rating, we continue to see WOW as a good, defensive business with strong market positions that should perform relatively well if macroeconomic conditions worsen. We may look to reassess our view on share price weakness.

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