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Woolworths reported a 65% drop in earnings over the 52 weeks to the end of June 2020 on Thursday morning; However, by lunchtime, the share price had risen almost 3% to R34.77 and by the close of trading it had risen 6.57% to R36.
It’s hard to imagine how bad things would have had to be to cause a stock price drop.
The slight recovery in the share price (still well below the R60 it touched last November) may have been because the Covid-induced share price drop had been exaggerated or because the market really wants to believe the story of Woolworths recovery.
This somewhat jaded history from three years ago was revitalized during the 2020 finances with the arrival of a new CEO and, more importantly, the group’s greatly improved cash flow. It is inevitable that the two are linked.
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With the very notable exception of its food business in South Africa, 2020 was a bleak operating year for Woolworths; And it wasn’t just Covid.
Margins
Certainly, the Covid lockdown in South Africa and Australia did significant damage (new CEO Roy Bagattini estimates it cost the group R2 billion), but it does not explain the extent of the collapse in operating margins across the group (again, with the exception of Woolworths Alimentos which increased the operating margin to 7.7% from 7.2% in 2019).
In Fashion, Beauty and Home, the operating margin fell from 12.1% to 7.6%; Australia-based David Jones managed to cut his already narrow 2019 margin from 1.7% to 1.1%, turning it into a loss before interest and taxes; while at Country Road, also based in Australia, management saw operating margins plummet from 9.2% to 6.5%.
Not tempt
While the actual operations looked bleak with the wrong product, the wrong price, or the wrong format failing to attract enough customers, it was necessary to work on the balance sheet to inject some verve into the management’s jaded recovery story.
Cutting the second half dividend was probably the easy part, given that Covid-traumatized shareholders were prepared for exceptionally bad news.
Read: Woolworths scraps dividends, reviews Australasian real estate assets
“The good news is the much stronger cash flow,” says Alec Abraham of Sasfin, who believes that the new set of eyes looking at the business has had a significant and positive impact. Abraham says that while operating margins were significantly below his expectations, there has been a considerably better than expected improvement on the balance sheet.
Cash Flow
Group-wide cost elimination, inventory reductions, and expanded supplier and other payment terms helped bolster cash flow from operations and free up R1.6 billion of working capital. The David Jones property sale, which is an ongoing strategy, also helped.
The balance sheet is expected to continue to improve, and plans to cut retail space go beyond David Jones.
Abraham says there are also plans to reduce floor space in South Africa.
He describes this as a breath of fresh air, given how much space was wasted on management’s dedication to a seemingly unwieldy range of products. Plans to reduce capital spending to R1 billion will also help.
Bagattini says the balance sheet was a priority for him in 2020. Management has set a target of 1.5 times net debt to Ebitda (earnings before interest, taxes, depreciation and amortization) from the current two times. Bagattini presses on the weather to achieve that goal, noting that the current environment makes forecasting problematic. Then he adds: “Within the next 12 to 18 months.”
The new CEO denies that the only reason he has not sold Australia’s struggling, value-destroying, self-financing businesses is because there is no buyer.
“I have no sentimental commitment to companies, I am trying to create value.”
He believes they present a viable proposition, but realize that it will involve a lot more squeezing. “We have to make sure the juice is worth squeezing out,” says Bagattini.
Ironically, the Covid-19 crisis has helped reduce the pressure, as it has made homeowners more willing to participate.
Read: Woolworths launches contactless shopping service
Bagattini seeks to reduce David Jones’ retail space by 20% in two years. You would like leases to become variable components of the business. But it’s not just about the cost base, improving the way they trade will also be an ongoing challenge.
Local customers ready to be heard
On the local front, the Fashion, Beauty and Home division is likely to feel the pressure of some squeeze.
“We take our eyes off the customer and we don’t take advantage of the data we got from them,” says Bagattini, who talks about “that a lot of things are thrown away to see how it works.” It does not seem very good, given the discount that had to be made to liquidate stock.
Abraham says that the commitment to invest R750 million in reducing prices in the Food division reflects the group’s determination to increase its market share by changing consumers’ perception of high prices.
Bagattini, who stepped onto the bench just weeks before the pandemic did work that was already difficult and potentially insurmountable, told analysts Thursday that tough decisions had to be made, but assured them:
“Nothing is insurmountable.”
He told Moneyweb that shareholders would see evidence of the group’s “renewed strategy” by this time next year.
But Abraham cautions that the 2021 financial year is likely to see another drop in earnings, albeit a much more modest single-digit figure. However, expect a strong recovery in 2022 finances if the renewed strategy stays on track.
Listen: Woolworths CEO Roy Bagattini discusses the group’s results for the 52 weeks through June 2020.
