Woolies prepares for a food fight

The Woolworths share price touched a 12-month high on Thursday following the release of a comparatively strong set of interim results encouraging optimism that management is making progress dealing with a number of key problem areas.

But the early share price gains could not be maintained in the face of negative investor sentiment towards the South African retail sector.

That the Woolworths share price managed to close marginally firmer on the day, when most retail stocks lost 2-4%, was testament to investors’ belief that the group has at last turned a very long corner.

No interim dividend has been declared and shareholders have not been encouraged to expect a final payment despite the significant easing of debt and strengthening of the balance sheet.

One year in for new CEO

Although some of the progress embedded in the results may have reflected initiatives put in place by controversial former CEO Ian Moir, the appointment of a new CEO – effective one year and one week ago – appears to have encouraged expectations that the group is now securely on its way to recovering its former blue-chip status.

“Moir may have initiated some operational improvements but Bagattini [new CEO Roy Bagattini] has developed and consolidated them,” says Sasfin senior equity analyst Alec Abraham.

In major problem areas such as David Jones in Australia and fashion in South Africa, Bagattini has speeded up the planned turnaround strategy.

Trading space at South Africa’s fashion, beauty and health (FBH) business is expected to be cut by 7% before the end of June, and in Australia the group’s retail space will be reduced by 30% within the next two years.

Listening to the customer

The reduction in FBH trading space is part of a strategy that will see Woolworths cut back significantly on product range and brands. It is planning to exit from StudioW and WCollection clothing ranges as it tries to get back in touch with its core customer.

Casual wear ranges will be increased and formal wear cut back as the group pays more attention to the marketing data generated by its customers.

For investors who’ve become weary with an almost-decade long litany of apologies and excuses for the underperforming FBH division, the latest set of promises might have been unpersuasive were it not for the fact it was delivered by a new leadership team.

Not only is Bagattini, a former Levi’s executive, now in the top slot, former Markhams Menswear MD Mannie Maritz has at last taken up his position as head of Woolworths fashion.

Bagattini not satisfied

Bagattini described FBH’s performance during the review period as “extremely disappointing”.

Speaking to Moneyweb after the results presentation on Thursday, Bagattini said: “The challenges [at FBH] aren’t insurmountable, we should be significantly further ahead than we are.”

Abraham says it appears that Maritz is the first head of Woolworths fashion in many years to have identified precisely what needs to be done but he cautions it could be 12-18 months before investors see a sales turnaround; profitability should improve sooner with the planned space reduction.

David Jones

Within that 18 months it is likely that over in Australia the biggest of the David Jones challenges will have been resolved and the group either making some contribution to the bottom line or having been sold off.

Bagattini tells Moneyweb they have focused on improving David Jones’s product range and cutting costs – and not just real estate costs, which have been reduced by rightsizing the store base and renegotiating leases.

“We’ve extracted Au$20 million of overheads simply by running the business better,” says Bagattini.

He adds that in the past year they’ve been helped by not having to incur costs relating to travel, business meetings and big fashion shows.

Asked if the sale of the value-destroying Australian business is still on the cards, Bagattini says the focus has been on developing a plan to increase David Jones’s profitability, adding: “It would be remiss to say we are not considering all options.”

Abraham points out that sales in the last six weeks of the reporting period and the first six weeks of the second half (to mid-February 2021) at both David Jones and Country Road are very encouraging.

“The sales decline at David Jones is flattening and Country Road is nicely positive. If this performance can be maintained along with the improvement in margins and reduction in space, then Australia’s second-half results will be considerably stronger.”

That the group achieved an impressive 19.4% hike in adjusted diluted headline earnings for the 26 weeks to end-December 2020 despite its problem areas was partly attributable to another excellent performance from the South African food division as well as action taken to boost group cash flow and reduce debt.

Food, glorious food

The food division’s outstanding performance has gained it some market share, according to management.

Remarkably, the 10.9% increase in sales was achieved on margins that increased from 7.5% to 8.2%.

But Bagattini is taking nothing for granted.

“We have a target on our back,” he says, referring to initiatives by Pick n Pay and Checkers/Shoprite to get a share of the valuable top-end food market.

“It is very difficult to replicate our competitive advantage and our people are passionate and will fight tooth and nail against the competition,” says Bagattini, who refers to “a number of interesting opportunities” that will help sustain the performance of the food division.