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Snapshot Last Price Market Cap. 52 Week High 52 Week Low Shares on Issue Sector Moat Rating Intrinsic Valuation Risk Business Risk Pricing Risk Company Beta Sector Beta Low Medium 0.66 0.66 $23.91 $29,278 million $28.94 $23.21 1,224.5 million GICS - Food/Staples Wide $29.05
Event
The consumer electronics category, specifically Dick Smith, is under strategic review with a report due by February. After opening 21 new Australian supermarkets in FY11 (Coles 11) the pace accelerates with 25 to open in 1H12 and 39 for the full year (Coles est.13). This is an extremely aggressive and planned expansion of trading area with the goal longer-term shareholder value creation. A potential $2.5bn in additional annual sales is targeted which if achieved would see fresh sales around $12bn.
Investment Fundamentals Year-end Jun NPAT ($m) EPS () EPS Growth (%) PE Ratio (x) DPS () Dividend Yield (%) Franking (%) FY10A FY11A FY12E FY13E 2,020.8 2,124.0 2,230.0 2,420.1 163.2 173.6 181.6 196.0 8.3 6.4 4.6 7.9 16.9 15.7 13.2 12.2 115.0 122.0 127.0 135.0 4.2 4.5 5.3 5.6 100 100 100 100
Impact
While admitting the near term headwinds will likely see subdued trading through the remainder of FY12 long-term aspirations the focus is on high single digit sales growth and 10% EPS growth assisted by bolt-on acquisitions and capital management initiatives. We will look further into the OBrien strategy and report shortly. At this stage we retain our NPAT estimates for FY11 and FY12. Fair value is unchanged. The EPS growth target is well below that of the past decade of 18% and may disappoint.
Recommendation Impact
No change.
Business Description Woolworths (WOW) is a retailer with primary activities in Supermarkets - Food & Liquor - these represent the majority of group sales and EBIT. Other operations include: BIGW discount department stores; Consumer Electronics through Dick Smith, Powerhouse and Tandy; Petrol through the Woolworths/Caltex alliance; and Hotels following an active acquisition program. Supermarkets are also operated in New Zealand.
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The entry into home improvement could deflect management from the supermarket engine.
Financial Overview
Growth
We forecast sales growth (excl. Petrol), around 5% driven by reasonable comparable store sales growth and well planned expansion across Supermarkets and General Merchandise. Acquisitions will add to anticipated organic growth as will the entry into hardware/home improvement.
Profitability
Bull Points
WOWs dominant position in the supermarket sector is entrenched and coupled with first class management ensures it will maintain leadership in the sector. With the lowest cost-of-doing-business ratio WOWs operating margins are the highest driving cash generation which funds expansion and acquisitions while allowing management to entertain capital management initiatives. Above average expansion of supermarket trading area and the roll-out of the new 2015 store format with significantly increased space allocation for fresh product should lift sales growth and margin.
We forecast EBIT growth of around 6%-7%% driven by continued margin expansion. Further efficiency gains from the supply chain and ever increasing volumes spread over a relatively fixed cost distribution network should continue to drive improved margins.
Financial Health
Woolworths generates large cash flows with significant negative working capital. Cash flow comfortably finances operating capex. The balance sheet is robust and significant acquisitions are usually debt funded and topped up with equity where required. Excess capital is returned to shareholders.
Bear Points
Australia has too many supermarkets with retail space growing at a faster rate than the population. This is intensifying competitive pressure and will lead to reduced operating margins. Increased competition from a rejuvenated Coles and the potential entry of Costco will raise competition and lower operating margins. Possible regulatory pressure and legislation surrounding predatory pricing
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Growth
Year to 30 June Sales Revenue EBIT EPS DPS % % % % 2009A 5.2 11.8 11.7 13.0 2010A 4.5 8.8 8.3 10.6 2011A 4.9 5.0 6.4 6.1 2012E 4.8 6.0 4.6 4.1 2013E 7.2 7.8 7.9 6.3
Ratios
Year to 30 June Price/Earnings EV/EBITDA Dividend Yield EBITDA Margin EBIT Margin Net Profit Margin ROE ROA ROIC Net Debt/Equity Interest Cover % % % % % % % % % % x 2009A 17.6 9.7 4.0 7.2 5.7 3.7 27.0 11.9 21.4 34.2 12.8 2010A 16.9 9.3 4.3 7.5 6.0 3.9 26.7 12.0 20.7 36.2 13.6 2011A 15.9 9.0 4.4 7.5 6.0 3.8 27.5 11.0 20.6 42.4 11.7 2012E 13.2 7.5 5.3 7.7 6.0 3.9 28.3 10.4 20.5 37.8 12.1 2013E 12.2 7.0 5.6 7.7 6.1 4.0 28.2 10.9 21.3 32.0 12.8
Company Secretary
Mr Peter J Horton
Previous Research
27/10/2011 17/10/2011 08/09/2011 25/08/2011 28/07/2011 22/07/2011 21/07/2011 18/04/2011 10/03/2011 03/03/2011 25/02/2011 25/01/2011 24/01/2011 08/12/2010 20/10/2010 16/09/2010 13/09/2010 1Q sales disappoint Oh Oh Oh OBrien Price trigger adjustment Retaining positive stance FY11 below expectation guarded outlook A closer look at 4Q and FY11 sales performance Full-year sales result confirms good health 4Q sales 3Q sales growth at the higher end of the expected band Discretionary spending concerns addressed Engine room continues to deliver Impressive margin gains in Australian Food & Liquor Able to deal with competition Earnings downgrade as discretionary spending slides Headwinds in the near term but the model is not broken! Its a struggle in retail land! Not keen on participation in share buy-back Off-market share buy-back
Directors
Ms Jillian Rosemary Broadbent(Non-Executive Director) Mr James Alexander Strong(Non-Executive Director,Non-Executive Chairman) Dr Roderick Sheldon Deane(Non-Executive Director) Mr Leon Michael L'Huillier(Non-Executive Director) Mr Michael Luscombe() Ms Alison Mary Watkins() Mr Ralph Graham Waters(Non-Executive Director) Ms Jayne Hrdlicka(Non-Executive Director) Mr John Frederick Astbury(Non-Executive Director) Mr Thomas (Tom) William Pockett(Finance Director) Mr Ian John Macfarlane(Non-Executive Director) Mr Grant O'Brien(Deputy Chief Executive Officer)
2011 Morningstar, Inc. All rights reserved. The data and content contained herein are not guaranteed to be accurate, complete or timely. Neither Morningstar, nor its affiliates nor their content providers will have any liability for use or distribution of any of this information. To the extent that any of the content above constitutes advice, it is general advice that has been prepared by Morningstar Australasia Pty Ltd ABN: 95 090 665 544, AFSL: 240892 (a subsidiary of Morningstar, Inc.), without reference to your objectives, financial situation or needs. Before acting on any advice, you should consider the appropriateness of the advice and we recommend you obtain financial, legal and taxation advice before making any financial investment decision. If applicable investors should obtain the relevant product disclosure statement and consider it before making any decision to invest. Some material is copyright and published under licence from ASX Operations Pty Limited ACN 004 523 782 ("ASXO"). DISCLOSURE: Employees may have an interest in the securities discussed in this report. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf.
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Business Risk
Business risk encompasses all operational risk and financial risk. Companies with low business risk have the most reliable earnings streams. A change in business conditions may reduce earnings predictability and therefore increase risk. Examples are market entry of a new competitor, unfavourable shifts in the economy, changes in key management personnel, major investment in an uncertain new venture or acquisition, and increased interest burden caused by higher debt levels or raised interest rates.
Pricing Risk
Pricing risk reflects the premium or discount implied in the current price of the shares. Many growth stocks trade on high earnings multiples giving them high pricing risk though they may have low business risk. Investors should consider their risk tolerance before investing in the share market. Many investors will decide to have only low risk stocks in their portfolio though others will accept higher risk levels in order to pursue higher returns.
Recommendations
Our qualitative recommendations simple and easy to understand: are
Buy: Suitable for purchase now Accumulate: Undervalued but there is time to purchase Hold: Appropriately priced, neither buy nor sell Reduce: Sell part holding Sell: Sell all holdings now Avoid: Not investment grade
Intrinsic Value
Intrinsic Value (otherwise known as Fair or Underlying Value) is the analyst's interpretation of what the stock is worth today. The stock is considered to be undervalued when the quoted price is below this point or overvalued where the price is above it. Whether to invest in a stock will depend on consideration of the prospective return and the risk undertaken. Prospective return includes both share price moves and dividend yield. Our analysts incorporate the stock's risk in their intrinsic value. Other things being equal, lower risk stocks will have greater intrinsic value than higher risk ones. A stock becomes a buy when the quoted share price is at a discount to intrinsic value that provides a sufficient prospective return.
Economic Moats
The pursuit of high quality businesses is central to our investment philosophy. These offer the greatest gains to the long term investor, so long as they are bought at a reasonable price. The concept of economic moats is valuable in assessing the quality of a business, with the phrase popularised by Warren Buffett and Charlie Munger. Just as wide moats protected castles from invaders in medieval times, businesses with wide economic moats have strong defences against their profits being competed away.
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