By George Whitehouse, Clime Asset Management

Woolworths was founded in 1924 when ‘Woolworths Stupendous Bargin Basement’ opened for business in Sydney’s Imperical Arcade.

It took three years for Woolworths to become a ‘chain’ when in 1927 Woolworths opened a store in Queen Street, Brisbane followed by a store in Hay Street, Perth in 1928. In 1929 Woolworths opened a store in New Zealand and by 1930 Woolworths was operating 16 stores in Australia and New Zealand.

The Great Depression and World War II slowed progress but by 1959 Woolworths had opened its 300th store. In 1976 Big W was launched selling general merchandise in a format that proved successful and led to 13 Big W stores being in operation by 1978 in all states of Australia. In 1988 Woolworths was taken over by Industrial Equity Limited (IEL) at $3.65 a share and on May 31st was de-listed. Woolworths was to remain directly unavailable to investors until IEL under debt problems floated it again in June 1993 at $2.45 in what was the largest float in Australian history at the time.   

Today Woolworths is Australia’s largest retailer with operations across food and grocery, liquor & hotels, petrol, general merchandise, consumer electronics and financial services serving more than 24 million customers weekly across Australia and New Zealand. In 2009 Woolworths sold just over $49.5bn worth goods.

Woolworths also operates 23 Big W Optical stores staffed with qualified optometrists and via a joint venture with TATA in India services 40 retail stores operating under the Croma brand. Woolworths recently acquired a 25% stake in Gage Roads Brewery where it offers the private label beer ‘Dry Dock’ to its distribution network (what a joy owning the other 75% would be with a partner such a Woolworths to distribute your product).   

Woolworths has commenced its entry into the wholesale and retail hardware sector via a partnership with US home improvement company Lowe’s.

Woolworths management has the stated strategies of;

– Sales to grow in the upper single digits assisted by bolt-on acquisitions.

– EBIT growth outperforming sales.

– EPS growth outperforming EBIT growth.

– Cost of doing business (CODB) reduction of at least 0.2% per year.

– Maintenance of credit ratings and a disciplined investment methodology and approach.

Has management been successful in growing sales, EBIT and EPS over time while reducing CODB?

Performance Chart – Woolworths Limited (ASX:WOW)


The above table shows,

. Sales have grown at high single digits;

.  EBIT growth has outperformed sales growth and EPS growth has outperformed EBIT growth;

. Management has managed to squeeze an average 0.4% out of the cost of doing business each year.

Comparing managements strategy to the business performance over a reasonable time period, shows that management has done a fine job over the last decade.

Other measures of performance:

Management is a key ingredient to any successful business and Woolworths has had its share of good managers from Paul Simons to Roger Corbett and the current CEO Michael Luscombe who started with the company in 1978. The current nine board members own 891,684 shares in the business representing around $25m (Sep. 2009). Although not that significant in a company with a market capitilisation of around $35bn it should be sufficient to keep the directors focused on shareholder returns.    

Financial History & Forecast Chart – Woolworths Limited (ASX:WOW)


Management announced an on market share buyback with the first half results of $400m. We view this as a good use of shareholder funds as our valuation is above todays price. It should be noted the buyback basically offsets the shares issed under the management incentive and dividend reinvestment schemes in FY2010.

The new venture into hardware (via Danks and the US domiciled Lowes) will be a challenge for management. Bunnings has an established footprint and will no doubt provide strong competition. Management has targeted 150+ stores within 5 years and has began securing sites. Also Metcash has acquired just over half of Mitre 10 with an option for full ownership in a couple of years time. It appears a challenging time to be an independent hardware retailer. It will be interesting to see if the hardware division will become as profitable as the rest of the business.

Competitive threats include a researgent Coles offering, an ambitious Aldi, IGA and new enterants such as Costco.  

Woolworths competitive advantages consist of an efficient supply chain, a low cost culture and the network effects that come with scale. Customers vote with their wallets and the challenge is to keep them voting for Woolworths.   

Valuation & shareholder returns:

The significant components required for the valuation are listed in the table below.

Table 2      * Special Dividend

Table 3:

The above table shows that NPAT has grown every year for a decade and in each year operating cash flow has exceeded NPAT. This is a sign of a strong business. We can also see that dividends have grown every year taking into account the special dividend in 2001. It is pleasing to see that NPAT & dividends have grown faster than Equity over the period. A sign that management is working the equity in the business harder and the business has become more efficient via scale and network effects.

The table also shows that net debt / equity has been acceptable (<50%) in all but a couple of years (2005 & 2006). In 2005 & 2006 Woolworths made a couple of significant acquisitions in Australian Leisure and Hospitality group and Foodland in New Zealand. A retailer with the strength of Woolworths can handle some debt as the cash flows of its business are reliable and strong.

Over the review and forecast periods the business will generate NPAT of $16,203m and pay fully franked dividends of $10,457m giving us a payout ratio of 65%.

The average NROE over the forecast periods is 39.33%. In selecting an Adopted Performance Forecast (APF) an investor needs to review past performance and a form a view of the likely sustainable future performance. Being a little conservative is a rational approach so we have adopted an APF of 37%, of which Distributions (D) make up 26% & the Reinvestment of profit (RI) the remaining 11%.

Thus, we now have the key inputs StockVal requires to value Woolworths,

Using the above inputs and the equity per share StockVal produces the following values,

‘Time is the friend of the wonderful company, the enemy of the mediocre.’

Warren Buffett

An investor who purchased $10,000 of WOW shares in June 1994 shortly after the business was re-floated would have achieved an annual compound return of 19.52% ($121,450) compared to the All Ordinaries Accumulation Index return of 9.6% ($36,100) to June 2009.

‘The most powerful force in the universe is compound interest’

Albert Einstein

With a share price around $28 Woolworths is currently available at a discount to its intrinsic value providing investors with an opportunity to become a part owner in this wonderful business on business like terms. A reason this analyst owns shares and has recently purchased some for his 4 month old son.

Of course the future of Woolworths may well be materially different to the past and it becomes more difficult to earn outsized returns on equity as that equity grows. With a growing population and an ingrained retailing culture extending for the best part of a century the future appears bright.

Clime Asset Management and StockVal are part of Clime Investment Management (ASX:CIW).


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