March 8

Woolworths Group (WOW) – Margins under scrutiny

Woolworths is the largest supermarket chain in Australia and New Zealand, with 3,357 stores and more than 190,000 employees. Its business comprises Australian Food, New Zealand Food and Big W divisions. The non-cash goodwill write-down of Woolworths’ small New Zealand business in the first-half FY24 results has no direct impact on our $27.50 per share fair value estimate for the group, nor our underlying earnings estimates.

However, the turnaround of the New Zealand business is likely to take longer, with management citing a weaker medium-term market outlook as a reason for the impairment. We’ve reduced our group earnings estimates by an average of 1% over the next decade to FY33 and note that the New Zealand segment represents a mere 11% of group operating earnings over the period. Recent trading in New Zealand is underwhelming. EBIT for the first half of FY24 was down 40% on a year ago. We were expecting a recovery in the second half of FY24 but have now lowered our earnings estimate for the segment by 40% and 32% in FY24 and FY25, respectively. From FY26, our group estimates are unchanged. The core Australian food segment is performing better than expected, and based on our estimates, EBIT margins are holding up despite rising wage costs and moderating shelf price inflation. That said, the supermarket industry is facing an inquiry after complaints about price gouging, and those findings may play a role in margin outcomes. The solid performance of Australian supermarkets more than offset the disappointing result in New Zealand and the challenging macro-economic trading environment facing discount department store Big W. We marginally upgrade our full FY24 year EBIT estimate for the group by 1%, too immaterial to move our intrinsic assessment. Shares in Woolworths continue to screen as overvalued. In our view, the market is more optimistic on operating margins in the medium term and underestimates the risk of defensive yield stocks like Woolworths derating, given interest rate increases.


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