Wednesday, January 19

Exit Aus and List Woolworths Food Separately, Top Retail Analysts Say

Woolworths should exit its chronically underperforming businesses in Australia, David Jones and Country Road, and list its extremely profitable South African food business separately, says a report just released by Salmour Research.

The report indicates that the beneficiaries of this strategy would be the shareholders who “in the last five years have experienced a substantial destruction of value”.


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They estimate that the market capitalization of ‘Woolworths Food’ could be just under R50 billion, which is around 95% of the group’s current JSE market capitalization.

Read: Woolies get ready for a food fight

The report’s authors, Rod Salmon and Chris Gilmour, estimate the extent of the destruction of value, since the A $ 2.1 billion acquisition of Australia-based David Jones in 2014, at between R 34.9 billion and up to R 79.7 billion. of rand.

The last figure, which makes our eyes water, is based on assumptions about how well Woolworths would have continued to perform if management had not been distracted by its disastrous Australian adventure.

The authors acknowledge that their assumptions are based on the benefit of hindsight, but argue that they are made with a view to the future.

Seeing no signs of improvement, the R79.7 billion figure underscores the urgent need for the Woolworths board to take decisive action.


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“Given the trend of Woolworths management to lower medium-term profitability expectations for the David Jones business and the long-term downward performance trend worldwide for the department store format, a improvement in David Jones’ business is, in our view, highly unlikely.

“In our opinion, there is still a real risk of further damaging South Africa’s core business, both in trade and in investor perception,” the report says.

About R80bn explained

Salmon and Gilmour arrive at R79.7 billion by extrapolating the average growth in earnings per share of the Woolworths business between 2008 and 2014, a period that included the global financial crisis.

This growth was an impressive 17.1% annually.

“Being conservative and taking half of this growth rate, and extrapolating it to today, would suggest that profits for the South African business in 2019 would have been at least 50% higher than the combined business and in 2020, having account for an additional 50% reduction in 2019 earnings for Covid, HEPS closings [headline earnings per share] it would have been, in our opinion, at least 130% higher ”, says the report entitled ‘Woolworths – Breaking is difficult to do’.

Big differences

The hard-hitting report recounts how the original ambitious plan to create a retail giant in the southern hemisphere was disrupted by the reality of stark differences between Australian and South African consumers.

Instead of bringing the Woolworths concept to Australia, the David Jones department store format ended up in South Africa.

Everyone was dissatisfied. Except maybe the executives and directors.

Despite the decline in earnings per share, the report notes that “the base salary of the senior executive team increased on average by 111% and total compensation by 54%.”

Also: “The board that oversaw the David Jones purchase saw a pay increase of more than 90% during this time.”

Recalling the timing of the investment, Alec Abraham, a senior analyst at Sasfin, explained to Moneyweb this week that then-CEO Ian Moir had demonstrated the ability to turn brand equity into shareholder value in just a few years at the helm. from Woolworths.


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It was almost inevitable that he would get support for his Australian plan.

“At the time it sounded very convincing, they told us that the same kind of brand equity was involved in the two countries and that they planned to bring the David Jones brand tag from 2-3% of sales to 30%. The idea of ​​a powerful shopping machine in the southern hemisphere was very attractive, ”says Abraham.

Still, the forecast for operating profit margins of over 10% at David Jones seemed reasonable.

The flaw in the plan

However, what management, analysts and investors did not realize, Salmon and Gilmour say, is that consumers in South Africa and Australia have considerably different fashion tastes and quality expectations.

“We believe that Australian consumers viewed most of the South African product as substandard and / or potentially out of trend.”

It certainly didn’t help that in Australia the Woolworths name is tied to a low-end retail chain.

And in South Africa, the David Jones brand failed to win consumer support.


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Asief Mohamed, CIO of Aeon Investment Management, tells Moneyweb that at the time the problems for Woolworths’ South African clothing operation were exacerbated by the dramatic increase in competition from a host of international operators such as H&M, Zara and Cotton. On.

“Initially, the plan seemed exciting, but it quickly became clear that the strategy was not appropriate and it was certainly not working,” says Mohamed.

Seven years later, the forecast for David Jones’ operating profit margin is only 4-5%, which is lower than the 2014 level.

Letting go

Dumping Australia is a strategy now supported by most analysts and investors, but, as Salmon and Gilmour acknowledge, it could prove challenging.

The authors propose four options that have different degrees of attractiveness:

  1. The most attractive would be a merger with Myer (based in Australia) to create an Australian department store group;
  2. The next most attractive would be to spin off and separately list Australian companies on the Australian stock market;
  3. The third option would be to sell the businesses, which would be difficult and would have to involve incentives but would be better than the fourth option, which is:
  4. Closing.

Salmon and Gilmour believe that the Woolworths board is preparing to exit the David Jones business, but not the Country Road Group, noting that its loan requirements have been separated from the group, that the properties have been sold and the business, for now, it is positive in cash.

Easier said than done?

But implementing any decision will be difficult because the David Jones deal was proportionately too big for Woolworths.

Mohamed acknowledges that the sale of David Jones has been on the cards for some time, but publicly confirmed that it would affect the price.

He also questions why Woolworths is even in the clothing business in SA, but acknowledges that it would be difficult to get him out of the food business in the short term because the two are so intertwined. For now, the best thing they can do is keep reducing the floor space for clothing.

Abraham believes that as long as Woolworths does not have to finance David Jones, there is no urgent need to sell him; meanwhile, management should continue to focus on reducing its Australian cost structure and ordering its clothing businesses in South Africa.

Moneyweb contacted Woolworths for comment, but the group declined, noting that it could not comment because it is currently in a ‘closed period’.

Woolworths’ earnings release next week may shed some light on the board’s plans to recoup some of the lost value from its shareholders. Or not.

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