David Jones dragging Woolies down
Unsentimental new CEO vows no SA cash for Aussie chain
● Fund managers and analysts are watching keenly to see if new Woolworths CEO Roy Bagattini can finally turn around Australian department store chain David Jones, which has been a drain on the group since it was bought in 2014.
The task is daunting as the JSE-listed food and clothing retailer has already impaired R13bn of the R21.4bn it paid for David Jones.
Bagattini, a former SABMiller and Levi Strauss executive, says the “jury is still out” on what the investment case for David Jones will ultimately be.
And while some long-suffering shareholders would probably welcome Woolworths exiting David Jones, a sale of the business is probably not possible at this stage because it is inextricably linked to the Country Road business in Australia, whose assets were used as a cross-guarantee for David Jones’s debt.
The Australian businesses’ debt is about A$360m (R4.2bn). And even without that issue in the mix, the timing for a sale now is far from ideal.
“You’re not going to get anything for it now; you may get something for it next year or the year after when they’ve turned it around,” says Casparus Treurnicht, a portfolio manager for the Gryphon All Share Tracker Fund. “At this point in time nobody wants it. Australia has just gone back into another lockdown.”
Speaking this week after the release of results for the year to end-June, which showed group profit before tax falling 54.5% to R2.2bn, Bagattini, who was brought in as CEO in February, says his main priority in the Australian operations is to stabilise the balance sheet, which means focusing on ways to reduce debt.
He says the group’s working capital needs in that country generally increase towards peak season periods such as December, so the debt level can increase by up to A$150m more before normalising afterwards.
“The starting point and the priority for me has been the focus on the balance sheet, and to that end we’ve taken a look at the debt structure and, even prior to Covid, it was already unsustainably high.
“We’ve consequently identified how best to bring that into a zone we would be more comfortable with and we’ve identified different levers to pull.”
But Bagattini also says that he carries no “sentimental baggage” relating to David Jones and is “not wedded” to a “specific outcome”.
“The objective for me is how to extract the best possible value out of those investments in the interests of the group and ultimately in the interest of our shareholders.”
The group reported that while David Jones stores “continued trading during the second half of the [financial] year, there was a significant decline in footfall, which began earlier in the half, with the Australian bush fires and the Covid pandemic”.
It said turnover and concession sales declined by 17.2% in the second half of the year, bringing the full year about 6.4% below the previous year.
Bagattini also told investors and journalists at the virtual results presentation on Thursday that “there will be no further funding from here into David Jones”.
“In fact, our intention is to do the exact opposite, which is establishing a clear pathway to return value to WHL [Woolworths Holdings].”
Asked to elaborate in an interview later, Bagattini said: “My point about not putting any more money into Australia, or into David Jones specifically, from WHL is because I think there is enough solution there in Australia. They can wash their own face. They have enough capacity to deal with their funding structure issues and the funding of the business going forward in support of its strategies.”
Along with improving trading, Woolworths’ strategy for David Jones is to drastically cut debt by selling properties and then leasing them back from the new owners, reduce the division’s gross lettable area by at least 20% over the next two years and then remove up to A$20m of costs from the business.
As for the sale-and-lease-back agreements the group will be undertaking, Bagattini says the objective is to secure deals that are “market-related or better”.
He says what the group does not want to do is “sign a great deal, get another A$50m or A$80m or A$100m on a building, and then entirely burden the business going forward” with onerous lease agreements.
“Our objective is to secure leases that are market-related and certainly that’s the way we have approached it and that’s the way we have put out the bids.
“When we look at the bids that are coming, that is the ballpark that we are talking about. This isn’t about being crazy for the short term and realising a bit of value. It is about understanding what the optimum balance is between price and rental.”
Already the group has sold its Bourke Street, Melbourne, property for A$121m, the proceeds of which will go to reducing debt, and two other properties are under negotiation at the moment.
However, Shane Watkins, chief investment officer at All Weather Capital, is not convinced the group can secure market-related leases. He says the amount Woolworths can sell the David Jones properties for is “directly related to the future rentals they will pay”.
“A big sale price equals expensive lease payments for many years into the future. There’s no get out of jail here. For the most part the properties are single distressed tenant situations. Buyers know this and the only way they get good selling prices is to agree to pay exorbitant rentals in the future.”
Bagattini says the original lending agreements for David Jones do link it to Country Road and that “part of our objective around the balance sheet is doing what we need to do to pay down the debt so that we can decouple the two businesses and stand both of them up independently with their own funding structures to pursue what I think are their own strategic ambitions. That is the game plan.”
He says once the balance sheet is in a position
You’re not going to get anything for it [the David Jones department store chain] now; you may get something for it next year or the year after when they’ve turned it around Casparus Treurnicht
Portfolio manager for the Gryphon All Share Tracker Fund
the group is comfortable with, it will make a call on the future of David Jones.
“We’re optimistic that current levels of performance are going to improve.
“Our focus has been on getting the balance sheet sorted out. Once we get to that point, we’ll make the right call. We have to make sure that the juice is worth the squeeze at the end of the day.”
Treurnicht says that though a sale right now would be unlikely, Bagattini does “not have any emotional links” to David Jones. “So don’t be surprised if he is still trying to work with the board and trying to convince them to throw it [David Jones] out. The reason why it’s going to be difficult is they are so far down the line.
“They have written off so much of the business there is barely anything left of it to write off. What are you going to get for it if you sell it?”
Treurnicht believes Bagattini will try to operate David Jones with a smaller footprint and make it “at least a little bit profitable” before considering selling it.