Sewing up margins in tough conditions
Both are battling in an environment of consumer constraint as the cost of living bites
Recent results from Woolworths and Truworths, former corporate cousins in the days of the old Wooltru retail conglomeration, show that the apparel businesses of the two companies are being affected locally by cash-strapped consumers, energy problems and port delays.
But Truworths’s UK business delivered a very strong performance, while Woolworths in Australia did not. Woolworths Food was its stellar performer.
Both companies are ramping up local production with domestic suppliers. “A large portion of their consumers are [in the] middle- and upper-income group, and high interest rates are biting that segment,” says Casparus Treurnicht, portfolio manager at Gryphon Asset Management. “The disposable income for discretionary spending is becoming more and more restricted as inflation and everyday expenses are eating their way into wallets.”
Truworths’s strong performance from Office in the UK offset the weak performance of Truworths Africa, though some question whether the performance in the UK is sustainable. One analyst says Office’s margins are relative to its largest peers in the UK, such as JD Sports, and Nike or adidas. “It’s very rare for the retailer to be earning more than the brand owner. Generally, what happens is the more you start making, the more they come back at you and manage your gross profit margins down a bit.”
Woolworths’s clothing division is still struggling, and the company is investing in its value proposition and improving its product offering. Woolworths Food delivered the strongest same-store sales growth in the sector.
Damon Buss, equity analyst at M&G Investments, says what is interesting is how Woolworths food, beauty and home (FBH) has shifted focus to managing the margin (and hence profitability), which comes at the expense of lower volumes. Truworths employs the same tactics in South Africa — that is, to always protect gross profit margin. “Both businesses are struggling to grow their customer bases.”
Buss says the key divergence is in the performance of the companies’ non-South African operations. “Office is performing exceptionally well for Truworths, while Country Road Group [CRG] is struggling for Woolworths and is a long way off the targeted 12% earnings before interest and tax margin.”
Truworths released results for the 26 weeks ended December. Gross profit margins held their own at 53.6%, against 53.5% in the comparable period. The interim dividend was up 3.8%. Cash generated from operations grew from R1.7bn to R2.7bn, and net debt is down from R854m to R124m. Office had growth of 33.1% in rand and 15.6% in pound. Truworths Africa was down 0.3%.
In terms of apparel, Woolworths CEO Roy Bagattini says that over the past three years the company has been working to better understand the customer, the market and segmentation. A few years ago, 70% of its products were sold at full price; today it’s above 80%, indicating a reduction in markdowns, which has improved the profitability metrics. “Our focus has been on getting profitability right and not chasing indiscriminate topline growth,” he says. And it is focusing on several “must-win” categories. “We’ve stopped trying to be everything to everyone; you can’t be a broad church.”
While top-line growth has been constrained by port delays, there was also an “own goal” in terms of a lack of product availability, acknowledges Bagattini. The group is changing how it handles logistics to be more flexible, and is keeping more product back to allocate only when required. Placing smaller orders more frequently helps reduce reliance on one shipment, and while the company uses air freight occasionally, it’s costly and not sustainable. Bagattini says availability is the single biggest focus for the FBH teams. The shift in the next phase is about inventory and availability.
Woolworths Food continues to gain market share. Its adjusted operating profit grew by 13% to R1.59bn, with a margin of 7% for the period. Food sales, which contributed more than half of the group’s revenue in the half-year period, increased 8.2% in the six months to December 24. The group reported a 7.5% fall in half-year headline earnings a share, though the financials for the first half of the 2024 financial year are not comparable with the period, as David Jones was included in the previous interim period.
Woolworths continues to head into adjacent businesses, from pet care to liquor and cafés, and it has set up an accelerator, Woolworths Ventures, to be able to tap into opportunities fast and avoid being beholden to a corporate structure. Bagattini says he’s happy with the strategy and how it is being executed. “This is no time to knee jerk — that’s what we always did in the past. We’re mindful of staying the course … we’re focused on optimising, investing and growing our business.”
Trading conditions in Australia have declined further, with consumer sentiment at near record lows and household savings the weakest since the global financial crisis. Traffic is down 20%30% across the sector for all retailers in that country. But Bagattini says there are no plans to exit Australia.
He says it’s cyclical; CRG is self-funding and still contributed a meaningful R600m of profit to the group over the period.
CRG sales for the period declined 5% and by 9.5% in comparable stores. “I see this more as a moment in the cycle; the impact on profitability is therefore more short term in nature.”
The group is spending R10bn on investment over three years as it rolls out new stores, improves others and invests in network, technology and distribution and logistics. “The single biggest investment opportunity lies within our own business and of course in our own shares,” says Bagattini.
Treurnicht says Woolworths’s results were mediocre. “Woolworths promised that it will be getting the FBH division back on track, but this seems to have hit a speed bump again,” he says, adding that competition is intense and retailers are fighting for limited disposable incomes.
Truworths group operating profit grew 7.6%, driven entirely by Office. Truworths Africa (about 72% of financial 2023’s operating profit) was down 2.7%. Office’s sales growth appears to be slowing sharply.
Truworths continues to generate impressive cash flow and returns for investors, albeit with limited growth, according to a note from Investec Securities. It says management delivered a credible result, with headline earnings per share growth of 3.6% year on year. This was driven by Office earnings increasing 30% in rand terms, while Truworths Africa declined by 5%.
A note from Nedbank says given the strong balance sheet (broadly debt-free), a resumption of the share buyback programme could be supportive.
The writers refer to it as a cash-generative machine. “We believe Truworths remains one of the most ‘disciplined’ retailers in the South African retail sector, given its organic growth strategy, strong cost focus, excellent margin management and attractive cash-generation attributes.
“Granted, growth is pedestrian at present, but prospects of an improving credit cycle would likely help drive some growth recovery in its South African operations, in our view”.