EUR 850.00 For Business Accounts Only

Morningstar | Corporate Action: Woolworths Buyback Could Appeal to Taxpayers Depending on Personal Circumstances

We expect narrow-moat Woolworths' buyback to be marginally dilutive to our valuation, given that it will probably be completed above our intrinsic value calculation. But we maintain our fair value estimate at AUD 24.50 per share due to the immateriality of the combined negative impacts of the dilutionary effect, slightly higher-than-expected losses at Big W in fiscal 2019, and the AUD 250 million in capital expenses to exit store leases mostly in fiscal 2021 and 2022.

As widely assumed, Woolworths is returning AUD 1.7 billion in funds to shareholders in an off-market buyback, following completion of the sale of its petrol business. Coinciding with the buyback announcement, Woolworths also provided an update on its struggling discount department chain’s footprint and expected operating losses. We had been advocating a rationalisation of Big W’s footprint as detailed in our special report "Australian Department Stores Are Going Out of Fashion," published Dec. 7, 2017. Now, management expects to close around 16% or some 30 stores by fiscal 2022, ahead of our estimate of 14% or 23 stores. However, we forecast the footprint to be continuously adjusted due to more sales shifting to the online channel as well as the loss in market share to online competitors such as Amazon. The decision to curtail Big W’s store network comes at a cost: an estimated AUD 270 million mainly to exit leases--of which AUD 20 million is noncash--and a further AUD 100 million in impairments due to management’s more cautious outlook on the trajectory of Big W’s EBIT margins. Also, Big W’s operating losses are likely to be higher than our prior estimate of AUD 35 million in fiscal 2019. Management expects losses of AUD 80 million-100 million. We have accelerated the near-term store closure schedule and delayed Big W’s recovery to break-even by one year. As disappointing as the news on Big W might be, the impact is immaterial on group earnings and our intrinsic assessment.

The buyback price will be between 10% and 14% below the five-day volume-weighted average price, or VWAP, to May 24, 2019. However, with much of the buyback price comprising a fully franked dividend, there could be material benefits to Australian taxpayers who have a low marginal tax rate. The final buyback price is yet to be determined, but our preliminary estimate of AUD 25.80 is calculated using a discount of 14% to a hypothetical VWAP of AUD 30.00 per share. A capital component of AUD 4.79 per share will be paid, with the remainder paid as a fully franked dividend. At a buyback price of AUD 25.80, we estimate Woolworths to buy back 65.9 million shares, representing 5% of currently issued shares.

In certain circumstances, Australian shareholders such as superannuation funds or individuals on a nil or low marginal tax rate could achieve a better outcome than selling their Woolworths shares at a higher price on market. Assuming a buyback at a 14% discount to a VWAP of AUD 30.00 for illustrative purposes the value of the dividend, franking credit, and capital component to an Australian taxpayer would total AUD 34.80 gross, or 16% more than the hypothetical market price. However, non-Australian taxpayers do not receive the franking credit, so they would only receive AUD 25.80 gross, or 14% less than the market price. The posttax value to investors is dependent on various factors, including their marginal income tax rate, the price paid for the shares, how long they've been held for, and any existing capital gains from other assets.

The final buyback price will be determined May 27, 2019, after the close of the offer. Investors can determine a price or discount to VWAP for which they would be willing to accept the offer. Participation is optional. New Zealand tax residents are also eligible, but tax implications differ from those of Australian shareholders. We encourage all shareholders in Woolworths to carefully review the buyback booklet and consult their financial adviser or tax accountant on whether to participate.