David Jones. Picture: SUPPLIED
David Jones. Picture: SUPPLIED

"It’s been an odd old year," Woolworths CEO Ian Moir said at last week’s results presentation.

Shareholders, who have seen the value of their investment in the retailer unravel, might be inclined to a blunter description of the company’s performance.

For one, the acquisition of Australian department store David Jones shows little sign of delivering what was promised when the R22bn purchase was signed four years ago. On the contrary, the decision to impair David Jones by almost R7bn resulted in Woolworths posting a full-year loss of R3.5bn.

Woolworths’ local fashion offering was roundly rejected by its core 35-to 50-year-old customer base, and only its food division showed any real growth.

Being in the fashion business means any retailer runs the risk of misreading trends. But in a note to clients, Investec analyst David Smith writes: "Outside of Edcon, Woolworths has by far been the worst apparel performer of the large listed players in SA over the past 10 years … This … suggests the problem is more than just bad product."

Smith says this has not been a big issue for Woolworths’ earnings in the past, given its ability to push gross profit margins "substantially ahead of the peers".

But he warns that "this is clearly not sustainable and suggests there is risk to either [gross profit] margins or revenue growth in the foreseeable future".

Investec Asset Management small-caps portfolio manager Andrew Joannou, a long-time Woolworths watcher, says the company "has never been particularly consistent as a clothing retailer. It goes through buying mishaps on a more regular basis than you would like."

Moir, the charismatic Scot who pushed the David Jones deal through, is clearly under no illusion that Woolworths’ woes are largely of its own making.

"We cannot blame our results" on tough economic conditions, he says. For one, choosing to make its Edition sub-brand a major feature in its fashion range, and then pitching it too young and too fashionable, just did not work.

While one misfiring engine is not necessarily calamitous for a business, the problem comes when all but one division is under strain.

Food sales grew a market-beating 8.4% and operating profit was 9.6% higher at R2.1bn, but clothing, beauty, Australian retail and David Jones are all a drain on the company. David Jones, for example, posted a 49.6% slide in profit for the year, to A$64m.

Excluding the impairment, headline earnings fell 17.7% to 346.3c a share and Woolworths slashed its dividend by almost 24% to 239c.

In Australia, says Moir, "it was a hugely disruptive year. We moved head office, we changed a huge number of our people in the process, we changed our merchandise systems, our financial systems, we started on Elizabeth Street, we launched a food business. We really did far more than any business should attempt. Much of it was necessary because they were interlinked, but there’s no doubt that it had a huge impact."

The Elizabeth Street store, which will become David Jones’s Sydney flagship, is costing Woolworths A$400m to refurbish, half of which is being paid by concessionaires such as Chanel, Gucci and Louis Vuitton. Asked at the results presentation about the cost, Moir said: "It’s a very large building and it’s about creating the most amazing and unique experience, and it’s in the quality of the fit. If you look at Louis Vuitton, [which is] taking a lot of the building … the build is exquisite, so it costs. You don’t get a store like the one we’re going to create for A$50m."

Ian Moir: Can’t blame results on tough economic conditions. Picture: Ruvan Boshoff
Ian Moir: Can’t blame results on tough economic conditions. Picture: Ruvan Boshoff

Woolworths says that, already, David Jones is starting to come right, with sales for the first seven weeks of the new financial year up 3.7%.

But analysts are worried that no matter how exquisite David Jones becomes, it will still fail to translate into a positive return.

"Not only [has Woolworths] made a poor upfront investment, but it’s going to keep needing capital and it may not generate a good return — it’s a lot to bank on. David Jones unfortunately has become the millstone around Woolworths’ neck," says Joannou.

David Jones is the reason Woolworths today has one of the lowest returns on equity (ROE) among SA retailers. For the year under review, ROE — a measure of how well a company uses investments to generate earnings growth — dropped to 18% from 20.8% the year before. In 2013, before David Jones was purchased, Woolworths’ ROE hit 50.4% — the highest for an SA retailer.

Another factor to consider is whether the food division can continue to outperform, particularly as staff incentives within the unit are partly based on group performance.

Though food sales have grown 7.6% post year-end, Joannou says Woolworths "must be careful [it doesn’t] start losing good food people and the food performance doesn’t start to deteriorate because people are being dragged down by other parts of the business".

The big question for investors, and for staff on any sort of share incentive scheme, is: where to for the stock?

Clearly, most of the David Jones destruction is already reflected in Woolworths’ share price, which has halved since its peak of R106.88 on November 5 2015 (a little over one year after the David Jones deal was wrapped up).

One analyst, who asked not to be named, says: "If we start getting to the low-to mid-R40 level, I think the market will have written David Jones off."

Vestact analyst Bright Khumalo thinks Woolworths is trading at decent value: "If you value the Australian business today at zero, Woolies should be trading where it is, so you’re getting the Australian business at nought. And with the rand becoming weaker, those [David Jones] earnings are going to become more important."

But not everyone is convinced that Woolworths has hit bargain levels yet. With SA’s economy unlikely to get better any time soon, and Australian retail still tough, Joannou says: "You really need Woolworths to execute on its self-help story, and unfortunately the potential turnaround is more of a worry than a positive given the difficult trading environment and the additional money it will cost."

"What are you really going to get very excited about in the year ahead, except self-help stories? " asks Joannou. They are more of a worry than a positive because [they] the self-help stories are going to cost time and money."

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