Woolworths’ Australian struggles overshadow good investment opportunities

Ian Matthews, head of business development at Bravura

David Jones continues to present problems for Woolworths; this time much closer to home. Last week, the company announced that it would be rebranding the David Jones clothing label under its own Classic Collection brand.  This is yet another setback that presents itself in what has been a series of unfortunate events for the company since its expansion into Australian a mere four years ago.

Woolworths’ beleaguered investment in the Australian retail market, bought for over R20bn in 2014 and partly funded by new equity, continues to place pressure on local operations due to the R6.9bn impairment of David Jones.

Woolworths recently reported that its home division, beauty and fashion saw a 1.5% decline in sales and a 4% decline in gross profit.  In contrast, the food division saw growth in sales of 8.4%.

Just over a month ago, S&P Global Ratings agency downgraded its rating on Woolworths from AA (having strong capacity to meet its financial commitments), to one notch below A+ (having a strong capacity to meet its financial commitments but is susceptible to adverse economic conditions and changes in circumstances).

S&P Global stated at the time that the downgrade was prompted by the drop in profitability caused by weak performances in Woolworths’ non-food businesses both here and in Australia. The ratings agency said that Woolworths could face further downgrades if its position in the non-food markets in SA and Australia weakens any further.

At first, the David Jones acquisition in 2014 appeared to be stroke of genius with a share price posted in November 2015 of R106.88 that pushed its market capitalisation to R111bn.  Last week, shares were trading at R50.93, valuing it at R53bn.  This dramatic decline almost certainly dulls the appetite of South African would-be investors’ considering opportunities in Australia.

Ian Matthews, head of business development at Bravura, a South African investment banking and corporate finance advisory firm with a presence in Australia, maintains that viewing Australia as an impassable investment destination is simply inaccurate.

Bravura has advised several South African businesses with regard to their entry into the Australian market.

“The Woolworths situation continues to overshadow the many successful acquisitions that have been made by South African corporates in Australian,” says Matthews. “As an investment destination, Australia offers hard-currency earnings and diversification made more attractive by a robust economy that has been recession-free for 26 years, with consistent GDP growth.”

Considering why Woolworths continues to experience challenges down under, Matthews cautions that an understanding of market needs is critical to successful investing.  “There is not necessarily strong growth across all sectors and investors must be aware of potential investment pitfalls.”

Woolworths attempts to claw back lost earnings include plans of expanding its food offering in Australia. Last year, it opened the Bondi Junction food outlet, offering both a restaurant and food store in Australia for the first time. New and expanded food options include sites in Wollongong, Melbourne and in Sydney’s Elizabeth Street store. Food is the company’s strongest performer in South Africa.

But, says, Matthews, it could prove a risky move given that the Australian upmarket food segment is somewhat different to ours, in that it is well-served by private delicatessens. Another strategy – refurbishing the David Jones flagship store in Sydney to the tune of almost A$200m, may also prove difficult. Matthews explains, “One has to consider that the department store model itself is under additional pressure from online players Amazon and eBay which are making the trading environment difficult for traditional retailers.”

Matthews says that Woolworths’ struggles underscore the imperative to ensure a thorough analysis of the market in order to understand its drivers, peculiarities and weak spots. “Retail is a highly competitive sector, even for local Australian companies, and the level of saturation is high.  A number of South African retailers such as Truworths, Clicks and Pick ‘n Pay who were front-runners in entering the Australian market, did not produce the results they were hoping for.”

Matthews says that there are other sectors beyond retail that present good investment opportunities and highlights the financial services and ICT sectors, where South African corporates have been able to reap rewards.

“Dimension Data and Datatec have completed numerous successful acquisitions.

And JSE-listed ICT company Altron holds total market share of 9% in Australia through Altech Netstar’s acquisitions in 2015 of local vehicle telematics company, Pinpoint Communications, and a further acquisition in 2017 of EZY2C, a local GPS tracking company. A technology-savvy and solutions-driven customer base makes Australia a hub for innovation.”

In addition, when considering Australian opportunities, Matthews cautions that South African businesses must be cognisant of the fact that Australia has an extensive regulatory environment.

“Acquiring a business in a regulated industry results in compliance obligations and associated costs which must be fully understood. For investors planning to establish or expand business operations in Australia as part of a diversification strategy, there are opportunities in the right sectors. But to maximise long term value, companies should ensure that they receive informed, local advice with an understanding of the South African investor perspective to effectively navigate the complexities.”

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