Woolworths: The negative side of COVID

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Alex Lu
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By Alex Lu
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Date posted:
14 December 2021, 12:00 PM
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  • Woolworths' (ASX:WOW) trading update overall was disappointing, with slightly better than expected Australian Food sales growth in 1H22 more than offset by significantly higher COVID costs, which had a negative impact on margins and earnings.
  • Management advised that 1H22 Australian Food EBIT is expected to be between A$1,190-1,220m (vs MorgansF A$1,375m). In addition, BIG W EBIT is expected to be between A$20-30m (vs MorgansF A$63m).
  • On the back of the trading update we decrease FY22F EBIT by 7% to A$2,693m . Our FY23 and FY24 earnings forecasts remain broadly unchanged assuming a return to more normal operating conditions. The key unknown remains further widespread COVID disruptions.
  • Our target price falls to (login to view) and we maintain our Hold rating. We think the 7.7% fall in the share price today reflects the disappointing trading update and WOW’s elevated trading multiples, notwithstanding long term fundamentals remaining sound.

Australian Food sales growth outpaced by costs growth

WOW advised that Australian Food 1H22 total sales to date were up 3.0%. While growth was above our 1.7% forecast, sales have moderated following the easing of lockdowns in NSW and VIC during October as customers return to more normal shopping habits.

Sales have also been impacted by inclement weather (mainly in NSW) which has reduced outdoor entertaining occasions, as well as an ongoing material decline in tobacco sales. 

Despite positive sales growth, ongoing material costs due to COVID have impacted earnings in 1H22. COVID has had a significant impact on costs both directly and indirectly due to the disruptions in the supply chain and the inefficiencies caused in store, distribution centres and transportation.

Supply chain costs were also impacted by higher volumes, fuel price increases and the impact of balancing supply across distribution centres on the East Coast. For 1H22, WOW expects Australian Food direct COVID costs to be ~A$150m (0.6% of sales) and indirect costs of between A$60-70m.

WOW anticipates both direct and indirect COVID costs to reduce significantly in 2H22 (subject to no further widespread disruptions) as the business returns to a more sustainable, predictable and productive operating rhythm and efficiency levels improve.

Online sales remain strong, up ~50% in 1H22. Online sales are lower margin, which together with a decline in in-store sales, has negatively impacted earnings. 

Management expects 1H22 Australian Food EBIT to be between A$1,190-1,220m, which was well below (-12% at the midpoint) our A$1,375m forecast.

BIG W impacted by store closures

BIG W sales have improved in 2Q22 versus 1Q22 as stores in NSW and VIC reopened during October.

Despite the improvement, given the impact of closures for much of the first four months of the half, BIG W’s 1H22 EBIT is expected to be between A$20-30m (vs Morgans A$63m).

Changes to earnings forecasts

We decrease FY22F EBIT by 7% to A$2,693m. For 1H22, we now forecast Australian Food EBIT to be down 9% to A$1,206m, NZ Food EBIT to increase by 12% to A$203m and BIG W EBIT to fall by 81% to A$26m.

Investment view

Our PE-based target price falls to (login to view). While the trading update was disappointing, there were extraordinary circumstances in 1H22 where both NSW and VIC experienced extended lockdowns and COVID caused major supply chain disruptions.

We think this situation is unlikely to be repeated (although never say never) with the long-term fundamentals of WOW’s business remaining sound. However, trading on 32.7x FY22F PE and 2.3% yield we continue to see the stock as fully valued and maintain our Hold rating.

Price catalysts

1H22 result on 23 February 2022.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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