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Morningstar | Woolworths’ Food Sales Rebound as Coles’ Promotion Fades. 24.50 FVE Unchanged

Narrow-moat-rated Woolworths Group’s sales growth from continuing operations slowed significantly to 1.9% in the first quarter of fiscal 2019 compared with the previous corresponding period. We were expecting much lower sales growth in the Australian Food division, but headline sales growth was slower in all segments from a year ago. However, we expect the group’s sales growth rate to increase over the course of fiscal 2019, with annual sales growing 2.5% over fiscal 2018, while group operating margins remain flat. We maintain our AUD 24.50 fair value estimate, and shares are screening as overvalued.

The core Food business grew comparable sales at a 1.8% clip, picking up momentum in the final weeks of the first quarter which continued into October 2018. In the first few weeks of the quarter, comparable sales grew by only 1.3%, but in the previous first quarter, like-for-like sales grew 4.9%.

Early in the quarter, sales growth was stifled by Coles’ incredibly successful Little Shop campaign. However, consumers aren’t very sticky in the highly commoditised grocery retail category, where price and convenience are king, and shoppers have returned to Woolworths. Management also called out the single-use plastic bag ban as a detractor to sales. We expect Woolworths to claw back the lost market share and to increase headline sales by 3% in fiscal 2019. However, we expect the bag ban will also be a temporary headwind for operating margins in the first half as staff numbers were increased to help with the transition, adding to its cost base.

WooliesX, the online food segment and a subset of Australian Food, grew sales by 26%, and we estimate this implies like-for-like in-store sales growth of only 1.1% in the quarter. Online sales are lower margin than in-store sales due to the additional labour costs of collecting and packing the items, and associated delivery costs for order not click-and-collected.

Together with fierce competition and higher wage costs, we expect online sales to weigh on operating margins. We estimate EBIT margins in Food to decrease by some 20 basis points to 4.5%--still ahead of Coles’ at 3.9% in fiscal 2018 and our long-term estimate of 4.0% for both Woolworths and Coles.

In Liquor, like-for-like sales growth of 1.7% was higher than rival Coles at 1.3% in the quarter. But this was much lower than the 3.3% a year earlier, due to a slowing liquor market, in particular wines. Headline sales were up 3.0% and we continue to forecast a slightly higher growth of around 4% for the full fiscal year 2019.

At the Big W discount department store, headline sales of 1.3% were about half the pace of the 2.5% rate in the first quarter of fiscal 2018. However, this is much better than our estimate of a decline of about 3% in fiscal 2019. Our bearish sales growth forecast is predicated on the gradual shutting of stores over the next decade, including fiscal 2019. Woolworths doesn’t disclose Big W’s online penetration but even if it was only at 2% a year ago, the 177% growth rate in online sales implies like-for-like sales in-store went backwards by about 1% in the first quarter of fiscal 2019. In the face of rising rents and wages, we expect stores will become less profitable as online penetration increases, offsetting the benefits the store network provides to click-and-collect customers. Hence, we forecast Big W to rationalise its footprint. In June 2018, Wesfarmers, owner of discount department store Target, announced plans to cut back its selling space by 20% over the next five years.
The balance sheet could be boosted in fiscal 2019, as the divestment of Petrol remains on the cards. Woolworths continues to pursue a dual-track approach, including an initial public offering and trade sale, to offload the AUD 1.8 billion Petrol business.