Woolworths posted an underlying net profit of $1.676bn, slightly below Ord Minnett’s forecast of $1.691bn, with earnings from the key Australian food and liquor business meeting our estimates but losses at the Big W discount department store chain proving steeper than we expected. The retailer declared a fully franked final dividend of 50cps, above our forecast of 46c, and a special dividend of 10cps.
We note the following key points from the result:
- Australian food like-for-like (LFL) sales growth slowed in the last quarter of FY18 and into the first quarter of FY19, due to the elimination of single-use plastic bags in NSW (leading customers to buy fewer items per basket), tough comparable numbers, the Coles ‘Little Shop’ promotion and fresh food deflation.
- Big W’s FY18 earnings before interest and tax (EBIT) loss of $110m was worse than our forecast of an $81m loss, but was within the guidance range of an $80–120m loss.
- Food EBIT margins rose 23 basis points (bps) in FY18, including 20bps in the second half, with higher gross margins again offsetting a rising cost of doing business (CODB) to sales ratio. Stock loss gains moderated in the second half.
The food turnaround has been very strong and we expect it to continue. We see investments in digital, offering, service and the supply chain – which has required significant capital expenditure – as sound uses of sales growth, and lower stock losses will aid gross margin expansion. This should support further sales growth and sustain the turnaround. We expect the EBIT margin to narrow in FY19 due to rising CODB, although Woolworths should keep its LFL leadership position due to its superior execution.
Given our forecast slowing in the EBIT growth rate and a lack of valuation support, we maintain our Hold recommendation on Woolworths and leave our target price unchanged at $30.00.