By Paul Rickard

Woolworths' CEO Brad Banducci delivered a very impressive full-year profit result yesterday. But the good news was already in the price. After opening almost 2% higher, Woolworths shares faded during the day to close (in a weaker market) at $26.94, down 12c or 0.44%.

As the chart below shows, Woolworths shares have risen by more than 20% over the last 12 months, and some 32.7% from the low of $20.30 in early July 2016. The market has well and truly telegraphed the recovery in the underlying business. Moreover, this has occurred in a hyper-competitive environment (Coles, IGA, Aldi, Costco), with the impact of Amazon and German retailer Kaufland still to come.

Woolworths - Aug 12 to Aug 17

Source: ASX

So, what was impressive about the Woolworths result?

Well, it wasn’t the headline number of NPAT from continuing operations of $1,422.1m. While this was better than analysts had forecast, it was still down 3.6% on the result for FY16.

The real highlight was the performance of the Australian supermarkets division. In particular:

  • It smashed Coles in the sales war. In the final quarter of FY17, comparable store sales growth in food was 6.4% (adjusted for the timing of Easter). Coles, on the other hand, only achieved sales growth of 0.6%;
  • The net margin in the supermarket business (EBIT to Sales %) improved in the second half to 4.48%, from 4.34% in the first half;
  • Second half EBIT of $791.5m was up by 13.2% on the corresponding half in FY16 of $699.4m. And although second half EBIT was down 2.5% on the first half, the former  had 25 trading weeks compared to the 27 weeks for the first half; and
  • Pointing to ongoing momentum, comparable store sales for the first eight weeks of FY18 are up by around 5.4%.

 Comparable Store Sales Growth

Other highlights included the performance of Endeavour Drinks, which in a very competitive market, achieved sales and EBIT growth, the latter by 3.9%. Financially, Woolworths strengthened its balance sheet by reducing net debt by $1.2bn, improved free cash flow, and lifted the return on funds employed from 21.7% to 22.3%. Shareholders were rewarded with a total dividend of 84c per share - up 7c on FY16, and about 9c higher than analysts had forecast.

Divisional EBIT

Big W continues to be the problem child for the group, although there were signs that sales are starting to stabilise. Final quarter comparable store sales growth, though still negative, improved to be down by 3.9%, better than the full-year slippage of 5.7% and the performance of competitor Target.  

EBIT for Big W slipped to a loss $150.3m for the full year ($123.3m for the second half). Looking ahead to FY18, Woolworths warned that the turnaround would be a multi-year journey, and while they hope to stabilise sales in FY18, underlying trading performance was not expected to improve due to the investment in product range, price and customer shopping experience.  

What do the brokers’ say?

Going into yesterday’s result, the brokers’ viewed Woolworths as fully priced. According to FNArena’s data on the major brokers, there were three buy, one neutral and four sell recommendations, with a consensus target price of $26.41, a 2.0% discount to the current share price. Although the FY17 result came in better than expected, the subdued outlook for Big W will temper upward revisions to earnings forecasts, and it is unlikely that there will be material changes to the target prices or recommendations.

Woolworths is trading at pretty hefty multiples, 24.3 times on a trailing basis to FY17 earnings, and 21.4 times on forecast FY18 earnings. This compares to Wesfarmers, which is trading on a multiple of 16.4 times FY18 earnings.

Trading Multiples (Woolworths and Wesfarmers)

Bottom Line

The turnaround that Woolworths has achieved with the Australian supermarkets business has been impressive, and they clearly have sales momentum over arch rival Coles. But this is an industry facing significant competitive headwinds. Further, Big W will be a drag on earnings for some time.

Low-growth industry, increasing competition, low dividend yield and a heady pricing multiple don’t add up to a buy in my book. I am not sure that Woolworths is a sell (yet), but it is not a buy. 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.