Woolworths posted a first-half FY18 underlying net profit of $944m, below our forecast of $957m. Like-for-like (LFL) sales were stronger than expected in food, New Zealand supermarkets and liquor, but earnings before interest and tax (EBIT) in these divisions were below our forecasts.
Operating cash flow was strong, with 125% cash conversion, although the interim dividend of 43.0cps was slightly below our forecast of 44.0c.
We noted the following key points from the result:
- Food LFL sales momentum remains strong, with 3Q18 starting well (up 4.0% LFL and adjusted for New Year’s Day).
- Food EBIT margin expansion is ongoing, but is slower as cost of doing business (CODB) investments in digital, offering and service are made to ensure a longer turnaround.
- The deepest losses at the EBIT level in Big W have already been plumbed, with the division doing more of the basics better. This drove a lower EBIT loss in 1H18 and a cut in FY18 EBIT loss guidance to $80–120m, down from $150m and in line with FY17. Price, loyalty and light store refurbishments were the key drivers.
- The balance sheet continues to strengthen due to strong cash generation.
The food turnaround continues at Woolworths and LFL sales growth remains strong, although we expect the pace of growth to moderate given tough comparable numbers to cycle in 2018. Nonetheless, we are confident that investments in CODB (digital, offering and service) are sound uses of the operating leverage gains from sales growth and the margin benefits from lower stock losses. This should support further sales growth and sustain the turnaround. The NZ supermarket operations are being refined in FY18, but are positioned to grow from FY19, while liquor remains a solid growth business. For Big W, the business is well-positioned for a return to profit, although the industry backdrop is challenging.
Valuation support exists for the stock, with double-digit earnings growth supporting the P/E multiple. We maintain our Accumulate recommendation on Woolworths and our target price of $29.00.