Will Willitts, 22 September 2015

Deutsche Bank has a ‘hold’ on Woolworths (WOW) and cut its target price to $27.00 target price.

“Sharp lift in petrol profitability boosted margins in FY15 We have taken a detailed look at WOW’s margins based on the disclosure in the FY15 result. The margin impact from substantial price investment has begun, but our analysis suggests FY15 profitability was boosted by a sharp and unsustainable lift in petrol gross profit per litre, in addition to the reduction in CODB (cost of doing business) from the lack of staff bonus payments. We expect both of these factors to unwind, which combined with further price investment and deleverage will likely drive a large margin decline in FY16. At current levels, the market is already pricing sharp margin contraction and we see some value but believe it is too early to invest ahead of the appointment of a new CEO.

“We have taken a closer look at Woolworths’ F&L margins which are no longer reported separately post the ACCC petrol discount restrictions. While FY15 FLP EBIT margin expanded by 22bps, we estimate F&L EBIT margin fell by 12bps in FY15 (c. 52bps in 2H15). The difference was driven by a sharp increase in the gross profit generated per litre of petrol. We estimate this contributed a 17bps boost to FLP margin, but expect this to unwind in FY16.

“Post the FY15 result, we have made revisions to the way we model gross margin and CODB for the F&L (fuels and lubricants) and Petrol businesses. Specifically, we have assumed that Petrol gross margins return to levels more consistent with history (c. 5¢ per litre) after sharp expansion in FY15 (c. 7¢ per litre). We have not made revisions to any of the other divisions. The net outcome was a c 2 per cent earnings downgrade at both a divisional and group level. We now forecast FY16 NPAT of $2,245.5m which would imply a c. 8.5 per cent decline or a c. 9.3 per cent decline at the EPS level allowing for the dilution from the DRP.

Extracted in full from the Australian Financial Review.

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