Throwing money at the David Jones problem

Woolworths group CEO Ian Moir was brimming with confidence when he plunged his group into the A$2.15bn (R21.5bn) acquisition of Australian department store chain David Jones (DJ) in June 2014.

The move, Moir boldly declared, was “transformational” for Woolworths.

The reality was that Moir had committed Woolworths to the worst strategic blunder in its 87-year history.

In its year to June 2017, Woolworths impaired the value of its investment by a huge $712.5m (R6.93bn). This was a tacit acknowledgement that it had grossly overpaid for DJ. The amount represented more than a third of the original acquisition price.

Profit-wise DJ is on the skids. In Woolworths’ year to June 2017 profit before tax came in at 25.3%, a reduction of $127m, and it decreased another 37.7% in the half-year to December, to $66m.

The DJ debacle has left Moir’s position as CEO looking vulnerable, but he is putting up a brave front. At the half-year results presentation he declared: “We are fighters, not quitters. We will get it right.”

Woolworths is throwing money at the DJ problem. DJ is in a “transitional phase”, says Woolworths chief financial officer Reeza Isaacs. It will involve group capex jumping from R2.59bn in 2017 to R3.8bn in 2018, with another big, unspecified spend to come in 2019.

Since July 2017 new merchandise and finance systems have been in place, but the really big money is going into the refurbishment of DJ’s flagship Elizabeth Street outlet in Sydney and the funding of its entry into the food market.

Refurbishment of the eight- storey Elizabeth Street store is a huge bet, and when complete will have set Woolworths back $200m. That’s not far short of capex spend on all SA operations in the year to June 2017.

Woolworths is also betting big on the introduction of food to DJ, a process set to have cost $100m between 2017 and 2019. But merely applying Woolworths’ SA food model to Australia will not work in a market already well served by privately owned, upmarket delicatessens. Woolworths is itself unsure of what model to follow and, says Moir, is now experimenting with three formats.

It’s not a message that will fill shareholders with confidence. But the more important question to ask is: is Woolworths flogging a dead horse with the overall departmentstore model? In terms of sales growth DJ got nowhere over the past decade. In the halfyear to December its sales came in at $1.1bn, 3.8% down on the same period in 2016, and at $2.2bn on an annualised basis — little changed from sales of $2bn in 2007.

Woolworths’ big-scale involvement in the troubled department store sector is a source for serious concern. So, too, is the profit slippage in its SA clothing division.

In the year to June the division’s profit before tax fell 6% to R2.17m, with an even bigger fall of 13.1% to R1.04bn recorded in the latest half-year.

“We got it wrong in womenswear design,” conceded Moir at the results presentation. “Fortunately, it is fixable. We have employed 17 new designers, with another 17 to come.”

Australian fashion division Country Road saved Woolworths from a complete profit train smash in its past halfyear. The division kicked in with a solid 15.7% operating profit increase to $59m, while in SA the food division shone with a 15.9% operating profit rise to R1.07bn. But it was not enough to prevent adjusted group headline EPS falling 8.8% and building on a 7.6% drop in the year to June 2017. Worse still for shareholders, the interim dividend was cut 18.4%.

The market has judged Woolworths harshly, hauling its rating down from over 30 in 2015 to 11.4.

Until there are clear signs that DJ can, as Moir put it, be fixed, it is a rating unlikely to recover meaningfully.