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Woolworths recently reported its first-quarter FY18 sales result. Total sales from continuing operations grew 3.7% in the quarter, compared with our forecast of 4.2%. We maintain our Accumulate recommendation on Woolworths with a $29.00 target price.

 

On a segmental level, we noted the following:

 

  • Food like-for-like (LFL) sales were strong, growing 4.9% despite a slowdown during the quarter (5.4% in the first eight weeks) and compared with fourth-quarter 2017 (6.4%). This was well ahead of Wesfarmers’ (WES, Hold) Coles LFL sales growth of 0.3%.
  • Australian Endeavour Drinks (its liquor business) LFL sales growth of 3.3% was in line with our forecast of 3.0%, assisted by market share gains.
  • Food & Liquor LFL sales grew 4.6% and, although lower than the 6.1% achieved in fourth-quarter FY17, represented the second strongest increase in LFL sales since first-quarter 2010, which saw 5.8% growth. Woolworths has maintained a large (420bp) lead over Coles with growth leads in both Food and Liquor, although we expect the gap to narrow in FY18.
  • Big W LFL sales grew 2.9%, above expectations, driven by cheaper prices and improved execution.
  • New Zealand Supermarkets LFL growth of 2.7% was in line with our 2.8% forecast.
  • Hotels LFL growth was strong at 4.1%.

The Food turnaround at Woolworths is well underway and we are confident the cultural change will see this improvement sustained. The recovery in LFL sales growth from second-quarter FY17 onwards, and in EBIT margins in the first half, suggests CY16 was the low point for Food EBIT margins. The drivers of improving margins in FY18 and beyond are expected to include falling stock losses, supplier support, operating leverage and cost savings, which are required to more than offset negatives of rising depreciation, energy costs and price investment.

 

Overall, balance sheet pressures are easing due to the improved Food performance, strong operating cash generation and the announced sale of the Petrol segment to BP, which should help reduce debt further and raises the prospect of capital management in the medium term. Big W losses are likely to remain flat in FY18 on the previous year with a turnaround uncertain, especially given the competition, although the first-quarter result was encouraging.  

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