Following the demerger of wide-moat Endeavour Group, we maintain our narrow economic moat rating for Woolworths which is underpinned by cost advantages related to the core Australian food segment. Our low uncertainty and Exemplary capital allocation ratings are also unchanged.

Post-demerger of its liquor retailing and hospitality, Woolworths is essentially a pure-play food retailer with significant competitive advantages over its Australian competitors, Coles, Aldi, and independent operators.

Our investment thesis on Woolworths stands. We expect Australian supermarkets to compete by passing on efficiency gains or cost savings to consumers through price cuts, rather than expanding operating margins and potentially losing share.

As a result, we think Woolworths will successfully defend its market share in food retailing at around 37% in the long term, while EBT margins are capped at around 4.5%.

The demerger of Endeavour Group separates perceived environmental, social, and governance, or ESG, risks associated with liquor retailing and gaming operations from Woolworths’ supermarkets business. We consider the now lessened ESG risks for Woolworths’ supermarket and department store businesses as immaterial to our fair value estimate and well mitigated by the company’s existing

Processes and procedures.

Financial Position of the company

Woolworths’ balance sheet improved with the demerger, including a pro forma net cash position of AUD 75 million as of Jan. 3, 2021. This has prompted management to consider capital management options and potential for capital returns of between AUD 1.6 billion and AUD 2.0 billion is flagged—subject to Board approval. We anticipate capital returns of AUD 1.8 billion to shareholders in fiscal 2022, and we expect Woolworths to comfortably pay out around 75% of earnings in dividends going forward. At our revised fair value estimate, Woolworths offers a fully franked dividend yield of 4%.

Company Profile

Woolworths is Australia’s largest retailer. Operations include supermarkets in Australia and New Zealand, and the Big W discount department stores. The Australian food division constitutes the majority of group EBIT, followed by New Zealand supermarkets, while Big W is a minor contributor.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

­­