The stock in focus this month is Woolworths (WOW), one of the best-known stocks listed on the ASX. WOW operates 1,138 supermarkets in Australia and New Zealand, as well as 1,445 liquor outlets including BWS, Dan Murphy’s and Cellarmasters. Other outlet categories include Big W, Hotels, Masters Home Improvement and Home brands.

In recent years, Woolworths has enjoyed a dominant position in Australia, with an effective duopoly, world’s best gross margins and strong customer loyalty. However, the competitive landscape started to change with the introduction of new operators from overseas brands and a resurgent competitor in Coles. At the same time, WOW embarked on an aggressive foray into the home improvement market against the dominant player, Bunnings.

Due to a combination of hubris and poor management, WOW failed to see the impact of maintaining too high margins and the extent of the challenge in attaining a competitive position against Bunnings. By the time the magnitude of these missteps was identified, WOW found itself with a new business generating unacceptable losses, loss of market share in its core business and eroding margins.  As profitability suffered, so did the share price. Management was forced out, and the need for a new strategy emerged.

Time for tough decisions

With crisis often comes opportunity, and when fund managers and short sellers pummel the company’s share price, it’s time to step back and see what the potential is going forward – particularly when there’s a quality business at the core of the company. With the change of management, some tough decisions are being made, and a plan for the turnaround is emerging.

The decision to exit the Masters business provides increased balance sheet capacity, free cash flow and tax losses that can be used against broader group profit for a number of years. It also clears significant management distractions (seen in the increased focus on Big W’s unproductive inventory issues, which have been addressed ahead of schedule with reasonable effect), and allows the free cash flow to be reinvested in more competitive pricing, to turn around market share losses.

If you would like more information, please call 1300 ELSTON or email info@elston.com.au and an adviser will be in touch.