Woolworths Holdings: Retail

The Company

Woolworths Holdings is an investment holding company, listed on the Johannesburg Stock Exchange and operates through two subsidiaries, Woolworths (Proprietary) and Country Road, as well as a joint venture – Woolworths Financial Services ( Proprietary). Woolworths (Proprietary) is a chain of retail stores in South Africa and certain countries in Africa and the Middle East. It offers a range of clothing, food and general merchandise, mainly under its own brand name. Woolworths contributes 88.8% to the group turnover and 89.4% of the profit before tax, and comprises the Woolworths Clothing and General Merchandise along with the Woolworths Food divisions. Food sales make up approximately 61% of revenues and about 35% of profits, due to higher clothing margins. The clothing division contributes 39% of Woolworths sales and 65% of profits. Woolworths targets the living standards measure 9-10 groups, and is predominantly a cash-based retailer with around 19.5% of sales on credit. This is a relatively low credit offering in comparison to its clothing retail peers.

Country Road is a chain of retail stores and concession outlets in Australia, New Zealand and South Africa, offering a range of clothing and homeware under its own brand name. It is listed on the Australian stock exchange. Country Road contributes 11.8% of the group’s turnover and 6% of its profit before tax. Woolworths recently announced that Country Road had agreed to acquire the Witchery group for an enterprise value of A$172m ($163m). The price represents approximately five times the normalised earnings before interest, taxes, depreciation and amortisation.

The acquisition allows Country Road to create a business of greater scale, diversified revenue streams and industry leading margin. The acquisition is expected to deliver more than 20% earnings per share accretion presynergies for Country Road, and synergies are anticipated to be a minimum of A$10m ($9.5m). The move is funded by a five-year term facility of A$92m ($87m) and a rights issue of up to the same amount. The acquisition will serve to strengthen the presence in the Southern hemisphere and provide a natural rand hedge.

Woolworths Financial Services (Proprietary) is operated jointly with the ABSA Group. Woolworths ( Proprietary) owns 50% (less one share) and the profits are equity accounted in Woolworths Holdings. Woolworths Financial Services provides customers with a credit offering to assist them to purchase merchandise in the stores. It also offers a credit card, personal loans and insurance products. Woolworths Financial Services contributes 4.6% of profit before tax.

As of the first half of 2013, the company owns 459 stores, of which 65 are beyond South Africa’s borders.

In the last five years, Woolworths has achieved an average sales growth of around 10.5% per annum and annual profit growth of around 17.2%. The expansion of Woolworths’s operating margin has largely been attributable to the firm’s combination of bulk, price, value, innovation and quality. Additionally, the company’s relatively low credit offering allows it to provide an attractive dividend cover of 1.5 times and a forward dividend yield of 3%. We have an Overweight rating on the stock, based on our 12-month price target of R87 ($10.6) and its current price-to-earnings ratio of 23x on our earnings estimate for 2013.

Development Strategy

Woolworths will continue to focus on its supply chain, and expects to mitigate the impact of the rand by providing higher volume and using fewer suppliers. We believe the acquisition of the Africa franchisees – 25 stores at R150m-200m ($18. 3m-24.4m) – should support gross margins in the second half of 2013, but we expect it to be given back in price.

The debtors’ book growth of 12% in the first half of 2013 is mainly due to credit card and personal loans.

Woolworths is the only clothing retailer where we are comfortable with strong credit growth, given: a) the profile of its customer – average income is R15,000 ($1828) per month, and b) current bad debt level is the lowest of all the retailers at 1.5%. The company is planning to roll out 60 financial kiosks in the next 12 months.