Woolworths Earnings: Sacrificing Recent Efficiency Gains Could Boost Market Share

We increase our fair value estimate on narrow-moat Woolworths WOW by 2% to AUD 27.50 after revising our longer-term estimates. Higher maintainable operating margins in the Australian food segment and the time value of money both contribute, but higher long-term capital expenditures detract. Fiscal 2023 underlying net profit after taxes of AUD 1.721 billion was in line with our forecast. The group’s core Australian supermarkets—generating close to 90% of operating earnings—beat our expectations, offsetting weaker results from New Zealand Food and discount department store Big W.

The board declared a fully franked final dividend of AUD 0.58 per share, bringing total dividends for fiscal 2023 to AUD 1.04 on a 74% payout. The dividend presents a 2.8% yield at current share prices and a yield of 3.8% at our fair value estimate.

Shares continue to screen as overvalued. We think a rerating of defensive yield stocks like supermarkets is an ongoing risk, given recent interest-rate hikes. Our unchanged weighted average cost of capital for Woolworths incorporates a risk-free rate of 4.25%, in line with current yields on Australian 10-year government bonds.

The solid EBIT margin expansion of Woolworths’ Australian food business is in stark contrast to the contraction in fiscal 2023 margins at key competitor, no-moat Coles. Woolworths has increased EBIT margins some 60 basis points compared with prepandemic fiscal 2019, driven by efficiency gains and operating leverage. However, we expect supermarket operating margins to decline in fiscal 2024, due to operating deleverage and intensifying competition.

We anticipate costs to rise more than sales, resulting in operating deleverage. Wages and other costs—including energy and contractor services, like cleaners and tradesmen—are inflating slightly ahead of sales growth.