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Brighter prospects for Woolworths

Brighter prospects for Woolworths

Written by Mohamed Mitha – Investment Analyst


It has been an eventful decade for South Africa’s iconic retailer, Woolworths. Their Foods business has grown into one of the most profitable in the world, while their Fashion, Beauty and Home (FBH) division has faltered and their Australian department store acquisition, David Jones (DJ), has been a disaster.
We explore the distinctive qualities of the Foods business that have contributed to its massive success and the value-unlocking opportunities for the underperforming FBH division.

Foods is a cut above the rest
For many years Woolworths Foods has been the primary source of growth for the group and is now the largest contributor to earnings (charted below). This business caters primarily to the higher-end customer, with quality private label products, fresh produce and prepared meal solutions as the big margin contributors.

Woolworths Foods’ overall strategy execution has been outstanding. Revenue has grown at 10% pa from 2010 to 2022, with earnings rising by 16% pa over the same period. The business’s return on capital is currently north of 70% – among the highest of all food retailers globally.

The long-standing commercial arrangement between Woolworths and UK retailer Marks & Spencer is a key strategic advantage. Woolworths Foods shares insights and learnings from experience, which improves their focus on customer engagement, innovation and product ‘newness’ in stores (they introduced over 2 000 new or upgraded product lines in the past year). The relationship has grown to become mutually beneficial in recent years as Woolworths Foods has refined their own product development capabilities.

Private label
90% of Woolworths Foods’ revenue is derived from their high-quality private label offering – developed in partnership with key suppliers. In contrast, competitors Checkers, Pick n Pay and Spar typically have 20-25% of sales generated from private label products, with the overall product quality and range far below that of Woolworths. Woolworths’ top selling, bite-sized, private label Chuckles brand, that has expanded to include 35 different items across three categories (confectionary, dairy and bakery), is a prime example of private label product success.

Supplier relationships are of paramount importance to Woolworths Foods. Many have existed for more than 50 years, having transformed and grown from start-ups or small players to be industry leaders and, in some cases, listed companies through their Woolworths relationship. They typically enter into exclusive five-year partnerships with suppliers (most are renewed) to collectively grow intellectual property and to invest in the supply chain. As these relationships take time to build, they are not easily replicable.

With branded products accounting for a small proportion of revenue, Woolworths Foods is able to run aggressive promotions on certain branded lines (eg Jacobs Kronung coffee and Lindt chocolate) without denting overall profitability. They have also strategically lowered the price points of key product lines to attract customers. For example, the average price of their poultry products was reduced by 20%, which consequently increased sales volumes and foot traffic into stores. Rotisserie chicken is currently the top selling product line.

Keeping it fresh
Woolworths Foods’ fresh foods offering is viewed as the best quality in the market. This is underpinned by their cold chain process, the success of which is proving to be an enduring structural advantage. As with private label products, solid supplier partnerships have aided in improving crop quality and yield through collaborating on best practices and unique insights. This is encouraged by an uncompromising view of the importance of the entire cold chain process and the careful management thereof, focusing on temperature control from the time of harvest to transportation, storage and finally in-store display. Every effort is taken to ensure that the entire cold chain process is unbroken and while this exacerbates the levels of complexity involved and subsequently the costs, the difference in end-product quality versus competitors is hugely apparent.

Woolworths Food operates a demand-led inventory model, where required quantities are forecast at store level and refined over time (based on historical patterns and market insights) to minimise waste. Other retailers tend to follow a supply-led strategy for fresh produce, typically sourcing from fruit markets where the produce is sometimes frozen prior to distribution.

Is the competition closing in?
While Woolworths Foods has had the upper end of the market largely to themselves, competition has intensified in recent years. Shoprite in particular has made strides in the premium market under its Checkers banner. They are actively focused on revamping their in-store experience, with the aim of repositioning it for the premium market. Checkers’ sales growth has recently outpaced that of Woolworths Foods and Checkers has also begun trialling smaller format stores that resemble those of Woolworths Foods. Pick n Pay are also in the process of repositioning a substantial portion of their store portfolio to cater for the upmarket customer.

Riches to rags
In sharp contrast to Woolworths Foods, the performance of the FBH division has been weak for the last decade, despite substantial market share losses from a very weak Edcon (the largest apparel retailer in SA a decade ago) over this period. Years of price increases have masked merchandising weaknesses, with divisional earnings trending backwards since 2017 (below left). Excluding contributions from new stores, the FBH division sold fewer products in 2019 than in 2007, significantly underperforming competitors. The Foschini Group and Mr Price, over the same period (below right).

By repositioning the FBH offering to be more fashion oriented rather than focusing on ‘great quality at a reasonable price’ (original positioning) and expanding their range to cater to too broad a market, they lost sight of their core customer and became too expensive for what they were offering. Basic competencies like effective range planning (ie adequately stocking popular sizes and ranges) were poorly handled. In addition, initiatives such as the replacement of their in-house W-Collection range with the David Jones label, further alienated South African customers.

Woolworths’ clothing supply chain has been slow to adopt global trends aimed at optimisation. Consequently, they have struggled to respond quickly to customer demand patterns, often resulting in having to commit to large order volumes for garments that may or may not resonate with customers. A less relevant product offering for a forgotten South African customer has caused consistently high levels of seasonal markdowns (to clear excess stock) and the ensuing plummet in earnings.

Following numerous ineffective attempts at turning the FBH business around, new management have identified the following key actions aimed at revival:

  • a reduction in the number of colours selected in a range (from around 48 to 6);
  • a 20% reduction in the overall range offered, with a focus on core categories including everyday wear and wardrobe essentials;
  • a larger emphasis on quality basics;
  • removal of the underperforming David Jones brand; and
  • the removal of unproductive retail space to reduce costs.

We view the de-emphasis on fashionwear and the return to good quality basics as a positive step towards rectifying the high levels of discounting and surplus stock. Narrower ranges should enable FBH to procure more volume of the same item, thereby encouraging lower prices within categories. While these changes will take time to implement and are not risk free, we see sufficient opportunity to make a meaningful difference to the overall profitability of the division.

Loosening the noose
David Jones, the Australian department store business owned by Woolworths, has destroyed substantial value since being acquired in 2014. However, following the selling of key properties, David Jones is now debt free and no longer dependent on financial support from the group. Loss-making projects (eg rolling out a foods offering in David Jones stores) have been discontinued and management is focussed on maximising shareholder value from the underperforming business.

Woolworth’s other Australian subsidiary, the Country Road Group, has done well in transitioning a large part of its sales from physical stores to online, which now contributes 30% (13% in 2016). While we don’t anticipate substantial growth from this division, the earnings outlook is stable, supported by a planned optimisation in the store footprint as more sales migrate to online.

While we are mindful of the threats posed by a revitalised Checkers and Pick n Pay’s plan for growth, we view Woolworths Foods’ structural advantages as enduring for this high-quality business. This, together with the opportunities available to unlock value across other key areas of the group that are within their control, means that Woolworths faces a more promising next decade than the last.