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Woolworths profits flat as food margins decline

Glenn Freeman  |  20 Feb 2019Text size  Decrease  Increase  |  
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The share sell-off following Woolworth's (ASX: WOW) disappointing half-year result today is a realisation that lower food retail margins are here to stay, says Morningstar.

First-half profit edged one per cent higher to $979 million but food sales growth lagged that of fierce rival Coles.

Woolies' share price fell as much as 6.5 per cent in early trade, as the negatives for investors seemed to outweigh confirmation that up to $1.7 billion from the sale of its petrol stations would be returned to shareholders.

"The market is expecting margins in Australian food to expand, which is the only way you can get earnings growth at such a high rate, but I think the market is reassessing the probability of margins in Woolworths' core food business expanding," says Morningstar senior equity analyst Johannes Faul.

He maintains his view that Woolworths is a good defensive stock, but believes it is considerably overpriced at current levels – and the market is gradually beginning to realise this.

Margins for the half ending December 2018 were in-line with the same period a year earlier, up just 8 basis points. Faul expects this number will worsen, possibly even turning negative in the second half.

"Higher wages are coming through, and all of their businesses are going backwards – Big W is still loss-making and will remain so this year."

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Operating costs of Woolworths' supermarkets reduced slightly in half-on-half terms, down 5 per cent, but a new enterprise bargaining agreement that took effect from January will see this number rise in the second-half.

Big W's earnings before interest and taxes fell $8 million during the half, a slight improvement on the $10 million loss a year earlier. Endeavour Drinks was down 6.4 per cent.

Morningstar's Faul points to the consistent increase in online sales, which earn almost zero margin, as a major headwind.

Online sales are lower margin than in-store sales due to the additional labour costs of collecting and packing the items, and associated delivery costs for orders not click-and-collected.

Online penetration in Woolworths Australian supermarkets continues to grow quarter-on-quarter, up from 2.8 per cent in Q3 2018 to 3.5 per cent in the Q2 2019.

This growth is even higher in its New Zealand stores, where online sales grew 40 per cent in 1H 2019, and now comprise 6.5 per cent of total sales.

Chief executive Brad Banducci said retail conditions were challenging and are likely to remain so.

"While the first half was below our financial expectations, we made progress in a number of important areas", Mr Banducci said on Wednesday.

"While trading across the group for the first seven weeks of the second half has improved following more settled weather, we expect a more subdued consumer environment to continue for the foreseeable future."

Woolworths shares today hit a two-month low of $28.30, and were down 5.3 per cent to $28.64 at market close.

Morningstar's most recent fair value estimate is $24.50, as set before the latest result.

is senior editor for Morningstar Australia

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