Woolworths differentiates itself from other South African clothing retailers through its successful high-end food retail offering in South Africa (30% of the company’s operating profit) and its Australian footprint via the Country Road Group and David Jones (36% of operating profit).
While the food business has been performing well, the clothing operations have been performing below expectations recently, given difficult trading conditions and the fashionableness of its merchandise being off the mark in certain key categories.
The macro environment was tough, but Woolworths also admits to losing market share to competitors, primarily due to fashion mistakes in womenswear. Management feel they tried to be too fashionable for their core customer, and will now shift back towards the more classic look. There was enough footfall in the stores, so they’re confident sales will improve as soon as they get the fashion right, given the loyalty of their customers.
FUTURE OF DAVID JONES
With department stores globally in decline, there may be concerns over the future of David Jones in its current format. Woolworths has written off about a third of the purchase price for David Jones in its last set of financial results, confirming that the business has been performing below its expectations. However, management have been making a lot of changes and investment to transform this business. These include IT system replacements to improve inventory management, the optimisation of the company’s real estate and roll-out of a new, high-end food offering.
Woolworths remains confident about the long-term potential of its food offering in David Jones, but has reiterated that this would involve a steady build-up as opposed to a quick, aggressive roll-out. The company is currently testing three formats, with initial experience quite positive. Once it has enough confidence in the format, a wider store roll-out will start.
LOW VALUATION
Woolworths is trading on a historical low valuation relative to its peer group. If it can successfully correct its fashion issues, there is material value to be unlocked in the share price over the medium term. Country Road has already showed a strong recovery over the past year. There are also early signs of improving consumer sentiment in both South Africa and Australia, which may provide a more supportive trading environment in the next year.
While Woolworths’ performance has been below expectation, the impact of fashion changes, modernised systems and improved economic conditions will only be seen in the coming year or two. Given the current valuation and long-term management track record, I believe we should exercise more patience in holding Woolworths to see if management’s stated improvement strategies deliver the desired result.
In my view the market has priced in very little improvement in Woolworths’ operating performance, so any signs of improvement should be supportive of the share price.
