Trading in April returned to more normal levels for Woolworths ((WOW)) after the boost in the March quarter from stockpiling of food and liquor across Australasia. Or has it?
Woolworths, like Coles ((COL)), has indicated April was too volatile to provide any real guide to sales in the fourth quarter but expects as restrictions are eased there will be a benefit from “low-risk home entertaining”.
Brokers are reluctant to extrapolate activity trends in April, given the lack of the usual spike from the Easter and Anzac Day periods because of social isolation. Still, the defensive nature of the business puts Woolworths in a strong position to navigate the current uncertainty.
Long life grocery items experienced the strongest growth in the quarter and fresh sales also increased materially. There was a shift from over-the-counter products to pre-packaged goods.
Like-for-like sales growth was 10.3% in the March quarter, behind Coles at 13.1%. However on a compositional basis, Citi notes there was a significant lift in items per basket, sales mix and inflation for Woolworths, which is traditionally positive for operating leverage as fewer variable costs are required to service the sales.
As social gathering restrictions slowly ease across Australia and more businesses re-open, Morgans suspects supermarket and retail liquor sales will remain elevated as people stay cautious.
Online growth was 26.5% in the quarter, which compares with Coles’ at 14%. Woolworths has now doubled its online capacity amid expectations of sustainably higher adoption rates. Credit Suisse expects the economics of online ordering will improve. New technology is important in creating a more efficient cost base online and the broker does not consider the economics will be simply driven by a step-up in costs.
While Morgan Stanley likes Woolworths’ defensive attributes Coles remains the preferred exposure given a more pure supermarket play and better yield. One or two quarters of heightened sales and costs are not material to valuation, UBS asserts.
Supermarkets are likely to exit the pandemic stronger, with higher market share, rich data mining and an opportunity to materially gain share of wallet over the longer term. Woolworths is assessed by the broker as the best positioned, given the acceleration of online business, its rewards program and capabilities.
Costs
Woolworths has announced $220-275m in incremental costs in the June quarter. Morgan Stanley considers this broadly consistent with its expectations for additional pandemic-related costs within the Australian food business.
Management also considers cost estimates conservative, should there be a second wave through May and June. Citi calculates in the second half sales growth of 8% and gross margin expansion of 30 basis points are required to offset cost growth. Macquarie assumes around 60 basis points of gross margin expansion will occur with lower promotional intensity and reduced stock losses.
Credit Suisse continues to like the stock, believing the elevated costs are largely temporary. Conversion of more consumers to digital engagement, online ordering and delivery would strengthen the company’s position in the long-term.
Moreover, the broker points out, cash flow is strong, the balance sheet sound and a dividend is likely to be paid. Still, on a relative basis Credit Suisse prefers Coles and retains a Neutral rating for Woolworths.
Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, upgrades to Buy with a target of $42.50, assessing that, in unprecedented and uncertain times, quality shows up.
The broker believes Woolworths is better placed over the longer term compared with Coles, given its $1bn investment two years ago that enabled the company to hold onto earnings margins and enjoy a significant packaging cost advantage as well as superior in-store execution.
Big W
Of note, sales accelerated at Big W, supported by the shift in mix and limited discounting. Management has maintained previous guidance for a profit in FY20 which Morgans considers a very good outcome given the tough discretionary retail environment, while Macquarie points out this would be the first full year profit in years for the discount department store.
Citi notes the sharp contrast with the Kmart and Target operations of Wesfarmers ((WES)) which are experiencing deteriorating sales trends and elevated discounting. Big W’s online business contributed one third of the chain’s 9.9% sales growth in the March quarter and has now reach 6.5% of sales.
Hard goods and home essential products are outperforming apparel across the retail sector, which may explain the better trends compared with this peers.
Credit Suisse is less sure that the strong performance of Big W can be sustained, yet acknowledges the comments regarding closer integration of digital capacity signals that Woolworths is leaning towards retaining this business.
Meanwhile, hotel earnings guidance indicates a -$30-35m loss per month while venues are closed and implies a -$100m second half earnings loss, Ord Minnett assesses. Macquarie, too, expects soft trading in hotels will continue for the remainder of 2020.
Offsetting the hotels weakness, Endeavour Drinks performed strongly and the shift to low-margin value categories has normalised, the broker points out.
The FNArena database has two Buy and three Hold ratings. The consensus target is $37.91, suggesting 7.9% upside to the last share price.
