Woolworths turnaround to be 'slow and long' say investors
Fund managers say the worst is not over for Australia's largest retailer, Woolworths, and that its supermarket margins could fall below 5 per cent – dragging down earnings across the group for another year or two.
"I think the journey of recovery will be a slow one," Ausbil Dexia's head of equities, Paul Xiradis said. "I don't think it will recover strongly."
Mr Xiradis believes Woolworths' earnings will hit a base in 2017, while some fund managers and analysts see earnings declining in 2017 and 2018 before starting to recover in 2019.
Australian food and liquor margins, which plunged 222 basis points to 5.2 per cent in the December half, dragging earnings down 32 per cent, could fall to 4.8 or 4.9 per cent as Woolworths cut prices to remain competitive with Coles.
Unveiling Woolworths' first loss in 23 years, Woolworths chairman Gordon Cairns warned last Friday that the turnaround could take three to five years. Mr Cairns announced that Brad Banducci would replace Grant O'Brien as the new CEO.
Mr Xiradis applauded Woolworths' renewed focus on everyday low prices (EDLP) rather than promotional discounts, and backed the company's plan to tailor ranges in stores to better suit local markets.
Competition not standing still
"That [EDLP] is something that worked very well in the past, and having special needs for each store would makes sense," he said.
However, he said Woolworths needed to improve its fresh food offer and boost stock availability to regain market share.
"It does take time – the competition is not standing still either," Mr Xiradis said.
Contango Asset Management chief investment officer George Boubouras said Mr Cairns and Mr Banducci had drawn a line in the sand, acknowledging problems that investors had been worried about for years.
These included an overly bureaucratic head office, lack of capital discipline, underinvestment in store refurbishments and poor on-shelf availability.
"Cairns and Brad are saying the right things and acknowledging the right things. But the turnaround is going to be slow and long," Mr Boubouras said.
"There's a risk [that margins] will go lower than that [5 per cent], and because of the risk to margins, it can get worse, but if they systemically show evidence of turning around, you can tolerate another bad half or two," Mr Boubouras said.
'Basics can't be ignored'
"The cultural turnaround is massive, but basics like having a support centre not a head office … it's Business School 101 in the northern hemisphere," he said.
"The refurbishments of supermarkets must be well communicated and it's critical that they get the basics right – they have to make sure they're never out of stock on key lines on a Sunday afternoon – the very basics can't be ignored."
Woolworths is one of the most shorted stocks on the market, with short interest about 8.3 per cent – twice that of other stocks with a market capitalisation above $10 billion.
With most of the bad news out of the way, short sellers may start to unwind their positions, providing some support to the share price, which fell to a 10-year low of $20.50 on Friday before closing up 2 per cent at $22.34.
But fund managers said that with earnings set to fall further, Woolworths shares were still too expensive. The stock was trading at a multiple of 14.5 to 15 times earnings.
"This result thus offered some relief, but it is likely to be temporary," Bennelong Australian Equity Partners investment director Julian Beaumont said.
'Challenging' outlook
"Earnings were weak across each division, making it a challenge to focus on the problems individually.
"The outlook is challenging. Momentum in the supermarket industry takes years to turn around, and Woolworths faces increasing competition – it is harder and probably takes much longer than thought.
"Margins were taken too high, and while they have been brought down to around the competition, the fear is that they will have to do some more for the customer to take notice," Mr Beaumont said.
Fund managers also said that while Mr Banducci, the head of food and former head of liquor, was "clearly capable", they were surprised Woolworths appointed an internal candidate as chief executive rather than an external candidate.
"The fact that [Woolworths] could not find a high-calibre international candidate for the CEO position perhaps suggests the extent of the problems it faces," Mr Beaumont said.
"While Mr Banducci appears capable enough, I think the company really could do with outside perspective and a fresh start," he said. "Taking out what you consider to be your best talent to run the group takes away from your ability to turn around what is your core business.
"The Wesfarmers model proves you don't need your retail expertise at the very top … Perhaps Mr Banducci's broader expertise can take the Goyder-type role, leaving him to appoint an international with deep retail experience to take control of the core business."
Mr Banducci and chief financial officer David Marr will visit shareholders in Sydney and Melbourne this week followed by a global investor roadshow.
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