Should Woolworths spin out and list its wildly successful food business?
It’s an intriguing proposal, contained in a new report by analysts Rod Salmon and Chris Gilmour of Salmour Research, who also suggest Woolies ditch its entire Australian venture — not just its disastrous David Jones department store foray.
"The real beneficiary of this would be shareholders, who over the past five years have experienced substantial value destruction," they say.
Destruction is no exaggeration.
Salmon and Gilmour argue that management has effectively wiped off R23.4bn plus a further R11.5bn in write-downs on the David Jones business. "This makes, on a conservative estimate, a combined R34.9bn of destroyed shareholder value and on a fuller basis, R42.2bn."
The analysts say the focus on David Jones is likely to continue to pull Woolworths down, even as its food business becomes the top-rated food retailer in SA.
Investors, they say, would value the food business higher were it not encumbered by the rest of the companies within the group, "from which it gains in our view, no synergies or benefit".
"We believe that Woolworths food, as a separately listed entity, would, with a higher operating margin and a unique position protected by high barriers to entry, have a higher rating than its peer group, being Pick n Pay, Shoprite and Spar."
According to Salmour’s calculations, Woolworths food is worth R48.8bn, or R50.42 a share. This, they say, suggests that "investors only value the food business as the calculated share price is 95% of the total company’s actual share price (as at July 5 2021)".
A cursory look at Woolworths’ latest results highlights the issue: while turnover for its fashion, beauty and home (FBH) business inched up just 3.5% for the 52 weeks to June 27, to R12.85bn, the food division posted a 7.4% rise in turnover to R37.7bn. Food brought in R3bn profit, while FBH made only R1.08bn.
Salmon and Gilmour believe clothing retail in SA is in much worse shape than a recent recovery in numbers might suggest, arguing that Woolworths would have fared a lot worse had it not profited from the demise of Edgars and the wider Edcon group. "This has in our view plastered over the real devastation that is occurring in the retail market. The signs are now there that Woolworths is facing a critical period in its history. Splitting the business into focused independent entities is the only way to save the SA business and realise full value."
But while the idea might be appealing on paper, others are sceptical it would work in practice. Says Protea Capital CEO Jean Pierre Verster: "I think it is practically very difficult to split the food business from the FHB business, mostly because if you think about how many of the stores are laid out, the food business is at the back."
While some stores have been realigned to give the space allocated to food its own entrance, Verster points out that "so many of the stores are not only connected with the food business, they are intertwined — they share a common interest".
Woolworths’ response is a clear no.
"We don’t have any plans to list Woolworths Foods separately," says group head of investor relations Jeanine Womersley. "We have a unique proposition of fashion and food integrated under one brand, which provides us with a significant growth opportunity and cross-shop potential."
Still, Woolworths is clearly doing what it takes to keep food the star of the show.
Woolworths SA CEO Zyda Rylands — who is credited with the food division’s success — was set to take early retirement at the end of September, but has been persuaded to stay on to run the division.
"I’m really pleased I have been able to convince Zyda to stay on and lead our food business," says group CEO Roy Bagattini. "She is the pre-eminent food retailer in the country and there would be no-one better placed to take the Woolworths food business forward. She was quite central to the architecture of the strategy that delivered 10 years of consecutive growth, pretty much all under her watch."
Woolworths is investing R750m in food to make some of its lines "more accessible" — for example it has seen significantly better poultry sales after accepting lower margins.
Salmour’s other recommendation, that Woolworths exit David Jones and even its entire Australian operation, is more likely to be realised.
Released from the restrictive noose of its Australian debt — Woolworths cut group borrowings more than 90% over the year — it posted a strong recovery in earnings, sales and cash flow for the year ended June and was able to reinstate its dividend, at 66c a share.
Much of the R10bn debt reduction came from the sale of David Jones properties in Bourke Street, Melbourne, and Elizabeth Street, Sydney, for net proceeds of A$120m (about R1.3bn) and A$504.4m respectively. This left Australia in a net cash position of about A$360m, a major turnaround from a year ago.
David Jones and Country Road are now set up independently of one another and can focus on improving their own underlying operations and financial performance. Much to the relief of investors and analysts, SA is no longer funnelling money into the offshore business, either.
Clearly, however, business in Australia — now experiencing Covid convulsions of its own — is hardly booming.
David Jones sales were up just 2.3% for the year, and Woolies was forced to close a number of its food stores and repurpose some big food halls in other flagship stores.
The group cut David Jones’s footprint by 6% and Country Road by nearly 3% in line with a three-year plan to reduce the footprints of both brands by at least 20% and 15% respectively.
As always, Bagattini says Woolworths is not wedded to a specific outcome in regard to David Jones. "I don’t have the obligations of the past. I feel comfortable that we will make the right decision for us as a group and for shareholders."
Bagattini, who took over nearly 18 months ago, is clearly keen to turn the FBH business around, describing it as the single biggest opportunity to reset the value of the group.
This has meant some tough calls. But, he says, "you can’t be all things to all people … you want to identify where specific opportunities lie and, more importantly, where they intersect with who you are as a brand".
Bagattini says the group is not simply chasing market share in fashion; the priority is to restore financial health by driving quality over quantity and increasing full-price sales. He’s introduced "guest brands" such as Sunglasses Hut, Birkenstock and Levi’s (he was president of Levi Strauss America before joining Woolworths).
Still overexposed to formalwear and menswear, Woolies has increased its mix of casual and athleisure brands and has radically simplified its trend and colour messaging. For example, where it has used up to 48 colour palettes previously, this spring and summer the number is being cut to six.
Bagattini believes Woolies clothing simply became too expensive, and too expansive: by June next year, floor space for the FBH division will have been cut 11% from where it was in June 2019.
The company is focusing on two distinct customer segments: "the savvy customer" — someone who is pressed for time, values quality and well-cut, well-made clothing — and the "trend-spotter," who values quality basics but wants on-trend fashion. Woolworths’ share of this combined market is less than 10% "and this presents a meaningful opportunity for us", says Bagattini.
He says the group has not invested enough in supply chain technologies, which has been disruptive, particularly for the clothing segment. "While product is central to the success of any apparel business, it’s not the only thing — it’s the entire ecosystem around it that makes the difference."
About 30% of Woolworths SA apparel production is local, and the aim over the next few years is to increase this to 40%. As for the possibility of buying local manufacturing capacity, Bagattini says: "Never say never."
The group is starting to roll out new formats, and the refreshed Now Now offering opens this month in St John’s Piazza in Sea Point, Cape Town. Woolworths CEO Roy Bagattini says they take the best from a food perspective and make it more convenient with more options. "Basically we’re creating a convenience format which has ready-to-eat on-the-go shops" integrating with convenience and accessibility. Something like Pret A Manger "but better", he says. Shoppers will be able to buy fresh and ready-made products, and ultimately be able to order home delivery through Dash.
— A dashing venture
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