How beautiful could turn ugly

GOOD: Woolworths is getting whacked just as hard by its customers as Coles has been for its (their) pathetic, arrogant and pointless “virtue signalling” in depriving shoppers of customer-friendly plastic bags.

Let this be an instructive lesson to other boards and managements – pointless virtue signalling doesn’t come free, if you not only pompously try to “instruct” your customers how they should behave but actually make it hard for them to buy what you’re selling.

And a further word to Woolies CEO Brad Banducci: after you stuff up by directly attacking your customers, don’t try to hide behind jargon in explaining why those customers are less than impressed.

Yesterday’s announcement admitted that sales had slowed in the opening months of the new year as customers “adjusted to the removal of single-use plastic bags”. No Brad, they didn’t “adjust”, they went elsewhere or bought less.

And no Brad, they

ANDREW ‘Twiggy’ Forrest’s Fortescue has unveiled a beautiful set of ugly numbers. The most beautiful – personally for ‘Twiggy’ – was the near-quarter billion dollars he pockets in dividends for the year.

Incoming CEO Elizabeth Gaines can thank her predecessor Nev Power for bequeathing her the “beautiful” elements of Fortescue’s operations in the Pilbara and the financials they produced. Indeed, I’ve never seen a company passed on to a successor in better shape. There were no skeletons, real or imagined, in the cupboard for Gaines to uncover and deal with.

What she will have to deal with, into what is an uncertain and could prove turbulent future, is the “ugly” side of the numbers: the way Fortescue has been managing to make silk purses out of sows’ ears.

It all comes down to what a difference two percentage points of iron ore quality can make. The big two in the Pilbara, Rio Tinto and BHP, ship out 62 per cent pure ore; Fortescue is at 60 per cent – and only ends up getting to that by a monumental effort of blending that Power achieved. That seemingly Coles, small difference translates to not just a huge, but getting huger, difference in price. Fortescue got $US44 ($60) for each tonne of ore it shipped over the year. Rio got $US63 (for the June half). BHP averaged $US62 for the year.

Critically the gap widened sharply over the year. In the 2016-17 financial year Fortescue was getting 77 per cent of the pure ore price for its ore; in the latest year it dropped to just 64 per cent.

The reason is the elephant in the buying room – China – was getting more insistent on taking the premium stuff. And with the three big global producers of premium iron ore – BHP, Rio and Brazil’s Vale – all increasing their output, Fortescue got squeezed.

It still got to sell all its ore but it had to take a big haircut on price.

There’s a trifecta of challenges and uncertainties for Gaines. China is not going to go back to buying more and more ore and pumping out more and more steel. So in a steady-state market, Fortescue is increasingly the global swing player. And that’s the best-case outcome. What if China actually started cutting back on steel production? importantly for shoppers, prices still kept going down – by nearly 2 per cent on average across the year.

In short, shoppers got more actual goods for the same dollar spend. But critically – positively – for Woolies, it actually managed to lift its margin from 4.5c to 4.7c in the sales dollar. That’s a win for shareholders built on a win for shoppers.

The ugly – but peripheral – numbers were of course Big W. Its operating loss did come down sharply, but you have to ask what is the point of it, especially in Woolies?

The only answer seems to be that, if Wesfarmers has to have its Target, then Woolies might as well have its BigW: in each case to give management an (unsolvable) problem to work on. But there’s a big difference coming. Soon Target will be sitting next to not only the wildly successful (and high-profit) Kmart but the high-profit (and still high-growth) Bunnings, when Coles is floated off. BigW will continue to sit next to the low-profit and low-growth Woolies. Whether by choice – the shifting towards a 21st century services economy; or being forced by President Trump and his “trade war”?

Thanks to the extraordinary decade-long effort in cutting Fortescue’s production costs, Gaines was able to get a strong bottom line – and ‘Twiggy’ his big dividend cheque; but that very success means there’s precious little room to move further down the cost curve.

This showed up even more starkly in the latest numbers. Power’s parting gift to Gaines was to wring another 4 per cent out of costs, but this was swamped by a 30 per cent or so fall in Fortescue’s iron ore price.

If you could stop the clock Fortescue was still in a very good place: revenue of $US7 billion ($9.6 billion), gross profit of $US3.2 billion (a gross margin of 46c in the dollar), debt (way down from where it was) of $US3.1 billion and capex running a little over $US1 billion a year.

But you can’t stop the clock. Gaines can thank Power for the best possible starting point; but she’s got to fashion a future out of the cold realities of Fortescue’s less than premium ore and China.