Purchase of Woolworths (ASX: WOW)

20th March 2023

Across the Australian Equity component of investor accounts we have bought Woolworths (ASX: WOW).

Woolworths is the leading Australian supermarket chain with c.36% of the food grocery retailing market. In addition to this the group also owns:

The Countdown supermarket chain in New Zealand.
Big W, the discount department store.
A majority stake in PFD, a wholesale food distributor to cafes, restaurants and other businesses.
Primary Connect, a supply chain platform that is increasingly providing end-to-end solutions for a growing number of external partners.
A 9.6% stake in Endeavour Group, Australia’s largest retail drinks network with the Dan Murphy’s & BWS brands as well as the country’s largest licensed hotel portfolio.

We are attracted to Woolworths for the following reasons:

It has a dominant market position in a concentrated, stable industry which gives it pricing power and hence an ability to better manage gross margins in this inflationary environment.
Longer term growth is supported by population expansion including ongoing immigration where we expect a rebound in arrivals.
Supermarkets should prove resilient as households face increasing cost of living pressures given the essential nature of the products sold.
It delivers strong operating cash flow and operationally the company is performing well with positive earnings momentum.

Woolworths has three key levers for value creation that we would like to highlight:

In recent years management has invested significantly in productivity initiatives, their supply chain capabilities and customer experience including online groceries where it is the industry leader. This has been at the expense of margin expansion. As these investments start to deliver – we have seen initial signs of the benefits in the most recent results – this is expected to translate into higher earnings.
It has also invested significantly in adjacent business opportunities such as the Primary Connect supply chain platform, business-to-business (or B2B) food retailing via the PFD acquisition and the emerging digital media business. Longer term these investments are expected to contribute a greater share to overall group earnings.
The turnaround of Big W that is clearly gaining traction with further improvements to contribute to ongoing earnings growth over time.

We think Woolworths is suited to the portfolio because resilient cash flows enable not only a stable dividend to be paid throughout the cycle, but also disciplined investment in both organic and inorganic growth to drive future earnings.

We have funded the purchase of Woolworths through the sale of Origin Energy (ASX: ORG) that is currently subject to a conditional proposal led by Brookfield Asset Management to acquire all the shares at a price of $8.90 cash per share. With the takeover subject to conditions including various regulatory approvals, completion of the deal is not a certainty. While not our expectation, should the deal not proceed for whatever reason there is the risk of a substantial sell-off, and so from a risk-reward perspective we sold it.

As always, thank you for your ongoing support, it is very much appreciated. If you have any questions or would like more information, please contact your adviser.

Warnings and disclosures

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