Throw­ing money at the David Jones prob­lem

Financial Mail - Investors Monthly - - Analysis - Stafford Thomas

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.

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