Woolworths CEO Brad Banducci described the year as ‘inconsistent’ given the plethora of disruptions. The trouble-baton has been passed to cost increases, but we see sales recovering to a 3-year trend pattern, with margins improving through the year.
Reported FY22 EBIT of $2,690 million was up 1% but this disguised a weak 1H22 followed by a very strong rebound in 2H22. The first half was messed up by supply chain disruptions, product shortages (remember those?), team absenteeism (COVID-19), and flooding. Sales increased 5.5% in 2H22 (3-year CAGR 5.2%) helped along by rising online sales and inflation of 3.6% in 4Q22 (Figure 2).
A little inflation is good for supermarket operators, but consumers are already reacting by trading down to value products and shopping less (frequency and trolley size). We are expecting a tougher 1Q23f before a recovery driven by lower COVID-19 costs and improving gross margin.
BIG W was hit hard in 1H22 from forced store closures due to COVID-19 restrictions. The silver lining was higher online sales which reached 14% of Kmart Group sales. Gross profit margin was hit by 83bp in 1H22 then recovered by 34bp in 2H22. The CODB (cost of doing business) margin went up by 326bp in 1H22 and a further 85bp in 2H22 due to high levels of staff absenteeism and sick leave. EBIT fell 68% to $55 million with a margin of just 1.2%. The first 8 weeks of FY23f have been good for BIG W with total sales on a 3-year CAGR basis up ~10%.
Discretionary spending by consumers is under pressure from rising interest rates but BIG W’s value product range becomes a strength in such conditions. BIG W has enough inventory on board to get through the Christmas trading period.
Investment view
The plague and pestilence of FY22 was not quite of biblical proportions, but it slowed WOW’s progress on its strategic goals. The strong 2H22 recovery suggests things are back on track operationally and inflation remains a tailwind for sales and earnings. But the sales rollercoaster continues as inflation begins to suppress consumer spending early in FY23f followed by another recovery.
The important difference in FY23f will be the (near) absence of COVID-19 costs and we expect margins will lift substantially.
There will be a drag on earnings from New Zealand given its slower time frame in exiting the COVID-19 cost bubble.
We also note the much higher overhead costs which reached $190 million in FY22, excluding the contribution from Endeavour. The company is guiding this element to $220 million in FY23f as costs associated with Quantium and data analytics kick in.
WOW has better sales momentum and less major project risk over the next two years than COL. We think this justifies the ~20% differential in PE ratio between the two, but our preferred stock in the grocery sector is Metcash (MTS). MTS trades at a PE ratio of 14x compared to COL at 21x and WOW at 26x.
Risks to investment view
Competition could increase and negatively impact WOW’s profit margins. Inflation may be less than predicted, or raw material price increases might not be sustained.
Recommendation
We have retained our Hold recommendation.
FIGURE 1: FY22 RESULT
FIGURE 2: AUSTRALIAN FOOD COMPARABLE STORE SALES GROWTH
FIGURE 3: ONLINE SALES
FIGURE 4: WOW VS COL
FIGURE 5: BIG W COMP SALES GROWTH
FIGURE 6: NZ SUPERMARKETSq
