WOW – Woolworths Limited

Will ‘Everyday Low Prices’ WOW you?
Woolworths Limited (ASX: WOW) is a retailer with primary activities in Supermarkets and Food & Liquor.  Other operations include BigW discount department stores, Consumer electronics through Dick Smith, Powerhouse and Tandy, petrol through the Woolworths/Caltex alliance and Hotels following an active acquisition program.  Woolworths have also ventured into financial services in recent years with the introduction of credit and debit cards and the much publicised venture into the home improvement sector via their brand ‘Masters’.

Woolworths Limited ‘Woolworths’ had their very successful “Fresh Food People” campaign launched in 1987 and again in the year 2000.  The year 2000 campaign was a result of ‘Project Refresh’ which you may recall gave us plenty of advertising on our TV screens about ‘Everyday Low Prices’.

Woolworths have recently launched the ‘Quantum Project’ with a focus on all aspects of the business.  The objective is to see a measured increase in net profit and reduced cost of doing business by 2015.

Is this business easy to understand?
Woolworths is a business we all know. While Woolworths have a number of activities across their group, Food & Liquor make up about 82% of the company’s earnings.  Fresh Food is the biggest single driver of the Woolworths business. Woolworths work with the very best farmers and growers in Australia to ensure that everything on their shelves is top quality.

Due to their size and purchasing power Woolworths have created a wonderful ongoing cash flow position.  They purchase their inventory from suppliers, often on terms longer than 30 days, yet receive payment for their sales from customers (the general public) at the point-of-sale.  What this essentially means is that Woolworths’ suppliers fund the day-to-day cash flow requirements of the business.

Does this business have a sustainable competitive advantage?

  • Woolworths does have a sustainable competitive advantage in Australia due to the size and scale of their operations.
  • Woolworths holds the market leadership position in Australian food and liquor.
  • Woolworths operate a number of household brand names apart from their supermarket offering which include BigW, Dick Smith, Beer Wine Spirits (BWS), Dan Murphys, Cellarmasters, Caltex/Woolworths petrol offering, Masters home improvement and Danks.
  • Woolworths have used their market position to create new revenue streams in recent years via financial services offerings and movement into the home improvement sector.

What are the risks facing this business?
One drag on the business in recent years is Woolworths’ consumer electronics brand, Dick Smith. In January 2012, Woolworths announced that it had completed a strategic review of their consumer electronics offering and is planning to divest Dick Smith from their business in stages.  Woolworths will close non-performing Dick Smith stores and add more consumer electronics products to the Big W range.  Woolworths is looking to sell the business as a going concern and have offered existing staff the opportunity to be employed in other parts of the Woolworths business.

The level of success of the roll out of Masters home improvement will play an important role in generating future earnings for Woolworths.  There is a risk that the Masters concept will fail.  However, with this risk comes the opportunity to be rewarded for success.  As we all know, Bunnings is the clear market leader at the moment in the home improvement sector and Woolworths clearly see the opportunity to take market share in this highly profitable sector.

The rising debt levels on Woolworths’ balance sheet in recent years is a growing risk…..
In 2010, Woolworths Net Debt / Equity ratio was 37%.
In 2011, this ratio increased to 42%.
For the first half of 2012, this ratio has increased again to 45.6%.

The increase in debt levels is a reflection of their investment in the overall business for the future.  The level of debt that Woolworths carry is one factor I will continue watching closely over the next few years.

Is it run by able and trustworthy management?
The relatively new CEO Grant O’Brien has been a Woolworths’ employee for 25 years.  Prior to becoming CEO, Mr O’Brien played a key role in the development of the company’s liquor business and expansion into the home improvement sector.  It is always a good sign if the new CEO of a company has been appointed from within its own ranks.

Woolworths stick to their strategic objectives when they present their half annual and annual results.  Woolworths keenly measure their performance across the same metrics at each half year such as profitability, earnings growth, cost of doing business compared to sales, average inventory days, return on funds employed, earnings per share and supply chain metrics.

In recent years, the management has made some tough decisions that have impacted the business in the short run.  These decisions have been made with a view to making the business stronger and more profitable in the long run.  The recent decisions taken have seen the share price fall from around the $35.00 mark at the end of 2007 to around the $23.00 mark in more recent times.  Time will tell if the decisions made will generate long term benefits.

Is it trading at a bargain price?

Woolworths is one of the largest businesses traded on the ASX and as such rarely trades at a bargain price.  This theme continues at the moment despite the share price fall highlighted above.

Company Code Rank 2010 Actual Valuation 2011 Actual Valuation Today’s Share Price Margin of Safety 2012 Forecast Valuation 2013 Forecast Valuation 2014 Forecast Valuation
Woolworths Limited WOW Silver 1 $27.90 $23.01 $25.67 -17.06% $21.86 $20.42 $25.63

*Please note that this estimate of intrinsic value is subject to change on a daily/weekly basis.

In summary, Woolworths is a business with a leadership position in the Australian food and liquor sector.  They have used this position to diversify their earnings in a variety of sectors such as petrol, financial services and home improvement. Woolworths has strong profitability and good cash flow but a growing debt position.  It has experienced management in place and is poised to start a new growth story in the coming years.

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This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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