The sales environment is fine, but costs are rising quickly and will have a big impact on the first half year result. We expect much of this to dissipate in the second half although rising online sales is creating a longer term margin issue.
WOW said EBIT in its Australian Food division will fall 8% in 1H22f, mostly due to higher operating costs in the order of $255 million. Fortunately, much of this is one-off in nature and we think around three-quarters of the increase will unwind over the next 12 months.
Unsurprisingly, COVID has had a significant impact on direct costs (extra labour for hygiene, safety, PPE etc) as well as indirect impacts from disruption to supply chain logistics creating inefficiency in stores, distribution centres and transportation. Direct COVID costs in 1H22f are expected to be approximately $150 million. Indirect disruption to stores and logistics will add $60-70 million to costs in the half.
Despite the transient nature of some of these costs, we estimate WOW’s underlying cost of doing business has increased by 6% pa over a two-year period. This is partly due to rising online sales which have lifted from 4.3% of sales two years ago to 11% currently. The associated cost of fulfilling online sales is due to 85% of such orders being sourced from stores where pickers can manage 100-150 items per hour whilst clogging isles with large cages and baskets (this cost is absorbed by the company). As WOW builds its capability for automation, a robot might be capable of picking 600 items per hour within a dedicated warehouse.
Separately, BIG W earnings for 1H22f have been hurt by almost 4 months of store closures in NSW and Victoria. This will drag EBIT down to $20-30 million compared to last year’s $133 million for the same period.
Investment view
CEO Brad Banducci said the challenging half-year had impacted WOW’s ‘operating rhythm’ as rising costs had dented earnings for the period. The expectation is for conditions to normalise, but the Omicron variant might yet delay this. It would be unwise to completely rule out further lockdowns if jittery State Premiers lose their nerve.
The short term nature of some of the cost increases disguises the underlying increases in eCommerce expenditure and some on-going COVID costs.
WOW’s growth in online sales has been impressive reflecting an advantage over its competitors. We think growth in online sales will slow to 10-15% in CY22 as customers revert to more normal purchasing behaviour.
Looking at WOW with a wider time lens, from FY19-24f we think total sales for Australian Food will grow at around 4.5% pa while EBIT can grow by 7.0% pa. This will lift EBIT margins above 5%. The near term view suggests the FY22f PE ratio at almost 33x is too high. We maintain our Hold recommendation on the stock with a preference for MTS in the sector.
