finance report
Financial highlights for the year included an improvement in operating margin from 9.5% to 9.8% and growth in headline earnings per share (HEPS) of 17.4% to 105 cents per share. Return on equity increased from 31.2% to 34.8%, enhanced by the full year effect of last year’s R1bn share repurchase.
Group sales for the 52 weeks to June 2006 increased by 16.3% compared to the same period last year. Comparable store sales growth was 9.9%. Clothing and home sales in the Woolworths retail chain grew by 12.4% in total and 8.2% in comparable stores with an average deflation rate of approximately 1% over the period. Food sales grew by 22.5% in total and by 11.9% in comparable stores with an average inflation rate of approximately 4.2%. Expansion in stores resulted in an increase of 6.4% in trading space in clothing and home, and 14.4% in food.
Country Road retail sales were 8.2% higher in Australian dollar terms with comparable store growth of 7.3%. Overall sales decreased by 1.7% in Australian dollar terms as a result of the decline in wholesale sales resulting from the planned change of its wholesale business to a concession arrangement.
HEPS growth was impacted by the non-comparable STC charge on dividends declared during the year. HEPS growth before the non-comparable STC was 22.9% with adjusted HEPS of 109.9 cents per share. HEPS dilution of 2 cents per share arises from share options granted in terms of employee incentive schemes.
| 2006 | 2005 | % | ||||
| increase | ||||||
| HEPS (cents per share) | 105.0 | 89.4 | 17.4 | |||
| Comparable HEPS pre-STC (cents per share) | 109.9 | 89.4 | 22.9 | |||
| Diluted HEPS (cents per share) | 103.0 | 87.3 | 18.0 | |||
| Total shareholder return | 36.9 | % | 52.0 | % |
In addition to the STC charge of R39.4m, 2006 earnings include non-comparable finance costs of R37.1m after-tax due to the share repurchase in March 2005.
The group’s gross margin has been maintained at 34.3% while expenses have come under pressure with higher than planned levels of bad debt and other non-comparable provisions including employee restructuring and incentive provisions. The growth in employment costs is attributable to an increase in full-time equivalent employees to support the new store roll-out, salary increases and an increase in the share based payment expense from R10.4m to R18.0m arising from share options granted to employees. IFRS 2 which governs the accounting for share based payments is only effective for options granted after 7 November 2002 and requires expensing over the 5 year vesting period. This charge is therefore expected to become more comparable from the 2008 financial year onward. Included in other operating costs is the financial services bad debt charge-off of R145.2m (2005: R106.0m) and an increase in the impairment provision for the financial services assets of R71.3m (2005: R65.7m).
The group’s effective tax rate has risen to 32.8% due to the reoccurrence of STC paid during the year on dividend distributions. In the previous financial year distributions to shareholders were made from share premium which did not give rise to STC. The effective tax rate excluding STC is 29.7% (2005: 27.8%).
The contribution of the food offering continues to grow ahead of clothing and home, and whilst the latter remains the dominant contributor to group profit, the more defensive, non-cyclical nature of the former will be an increasingly significant component. Similarly, our financial services business provides a significant annuity counter to the impact of higher interest rates with a conservative and well managed appetite for credit risk.
The performance and required returns of the group are managed on a segmental basis in accordance with each segment’s business model. Notable highlights in the segmental performance are the increase in Woolworths retail operating profit of 24.5%, which exceeds revenue growth by 6.8%, and the enhancement of the financial services return on equity to 11.7% which has been assisted by the share repurchase.
Key segmental performance statistics are included in the table below.
| Group | Retail | Financial Services | ||||||||||||||
| Woolworths | Country Road | |||||||||||||||
| 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | 2006 | 2005 | |||||||||
| Rm | Rm | Rm | Rm | Rm | Rm | Rm | Rm | |||||||||
| Revenue | 15 143.0 | 12 988.9 | 13 286.9 | 11 288.4 | 993.6 | 995.1 | 941.4 | 773.9 | ||||||||
| Operating profit | 1 490.3 | 1 231.3 | 1 069.2 | 858.7 | 19.0 | 24.4 | 402.1 | 348.2 | ||||||||
| Finance costs | 243.9 | 152.7 | - | - | 4.1 | 3.7 | 239.7 | 149.0 | ||||||||
| Profit before tax | 1 246.4 | 1 078.6 | 1 069.2 | 858.7 | 14.9 | 20.7 | 162.4 | 199.2 | ||||||||
| Return on equity | 34.8% | 31.2% | 58.6% | 71.4% | 6.2% | 10.3% | 11.7% | 9.5% | ||||||||
woolworths retail
Woolworths retail sales grew 17.7% to R13.2bn, with a 22.5% increase in foods sales to R6.9bn and a 12.4% growth in clothing, home and beauty sales to R6.0bn. Food turnover is now 52% of Woolworths retail sales. The continued high growth in food sales has been driven by comparable store sales of 11.9% and new space sales of 10.6%. With price movement averaging 4.2%, volume growth was strong at 18.3% for the year.
Clothing, home and beauty sales grew strongly in comparable stores recording an increase of 8.2% and 12.4% overall.
Sales trading densities for food and clothing and home are at an all-time high. Investment in new footage is directed towards growth in food retail space whereas sales growth in the clothing and home is expected to be driven by improved sales densities on existing space.
Woolworths retail gross margin has been maintained in the current year at 32.8% despite the lower margin food sales growth outstripping that of clothing and home. Whilst we foresee that gross margin may be diluted marginally in the future with the increasingly dominant food contribution, both businesses generate sustainable value for shareholders in their own right.
Expenses have been well controlled, increasing by 16.0% on turnover growth of 17.7%. Variable staff and occupancy costs grew in line with the increase in sales but were below the volume growth, displaying improved store productivity. The significant investment in capital projects in recent years will result in an increase in the depreciation charge in future years as projects come on-stream.
country road
Country Road’s performance has been solid with net profit after tax of A$3.3m (2005: A$3.2m). The shift away from wholesale sales has had a beneficial impact on gross margin, partially offset by a strategic decision to reduce price points. The net impact on gross margins was an increase of 1.5% to 53.7%. Pricing strategies were successful in driving volumes up 27% for the year. The 1% increase in expenses demonstrates the continued focus by management on controlling overheads.
financial services
Despite the low interest rate environment, a tougher credit environment led to an increase in the bad debt experience from a combined book value of 2.4% of book in the 2005 year to 2.9% before the cost of recoveries and 3.2% to 3.6% respectively after the cost of recoveries. The increased trend in delinquencies has been in line with other retail credit books in the South African environment and we are confident that the quality of the books and the credit management and collection methodologies will ensure that bad debt is contained within our target levels.
The Woolworths in-store card, personal loan and credit card books now stand at R4.5bn, up 22.3% from R3.6bn at June 2005. Interest income increased by 20.4%, driven by the growth of the book sizes, whilst interest yields remained largely in line with the previous year. External non-interest income grew strongly by 37.4% and continues to be a key focus area for growing an annuity income stream for the business. Operating expenses in financial services remained well controlled, increasing slightly to 8.1% of the book from 7.8% in the previous year. Operating profit before financing costs increased 15.5%.
The key performance statistics of the financial services segment are:
| June | June | |||
| 2006 | 2005 | |||
| Store card sales as a % of total sales | 32.1% | 33.7% | ||
| Interest yield on gross books | 18.9% | 18.6% | ||
| Weighted average usury rate | 20.0% | 20.3% | ||
| Average cost of funds | 7.7% | 7.8% | ||
| Total gross books | 4 667.6 | 3 785.4 | ||
| Total provisions | (212.6) | (141.3) | ||
| Net book | 4 455.0 | 3 644.1 | ||
| Provision as a % of book | ||||
| Woolworths store card | 4.4% | 3.9% | ||
| Personal loans | 4.3% | 2.5% | ||
| Visa card | 5.5% | 5.0% | ||
| Total all books | 4.5% | 3.7% |
The provision for bad debts is determined using statistical models based on historical experience, modified for recent changes in economic circumstances.
balance sheet
Total assets grew by 22.8% as a result of the strong growth in financial services assets, investment in property, plant and equipment and increased cash and inventory holdings. Net asset book value per share rose by 17.8% to 326.9 cents per share.
The store expansion and building of the new Gauteng distribution centre gave rise to the increase in property, plant and equipment. An additional investment property, adjacent to the Cape distribution centre in Montague Gardens, was purchased during the year.
Investment in accounts receivable increased 5% to R815.8m whilst accounts payable, which includes trade payables of R878.6m (2005: R761.3m) increased in line with merchandise purchases.
The increase in cash balances relates mainly to the securitisation structure and cash holdings in subsidiaries, which despite being offset in the local group cash management system, may not be offset against short term borrowings for accounting purposes.
cash flow and capital expenditure
Cash generated by operating activities prior to investment in financial services assets increased 62% reflecting better working capital management and an improved quality of earnings.
Our R637.9m (2005: R385.9m) investment in capital expenditure provides us with a sustainable platform for future growth. Our new distribution centre in Midrand, Gauteng is due to be operational in March 2007 and the implementation of our systems renewal programme is currently being rolled out. 35 new stores were opened during the year and a further 57 are planned for the next 12 months. These investment focus areas will continue to utilise the majority of capital spend in the year ahead.
financial risk management
Financial risks related to funding (liquidity and counterparty risks), interest rate risk and foreign exchange risk are managed by the treasury committee which meets on a regular basis. The funding requirements of the financial services and retail segments are assessed independently in line with their business models in order to optimise the respective funding structures. Our funding strategy, which attempts to balance the operational and systemic risks with desired returns, is to operate an ungeared retail business and to gear the financial services assets with 70% to 80% debt funding.
Liquidity risk associated with borrowings is managed by staggering the timing of maturities of borrowings and maintaining substantial short-term unsecured banking facilities. Unutilised banking facilities totalled R1.7bn at June 2006 (2005: R2.8bn).
Financial services assets and interest bearing borrowings carry interest rate risk. As part of the process of managing the group's fixed and floating rate borrowings mix, the interest rate characteristics of new borrowings and refinancing of existing borrowings are positioned according to expected movements in interest rates. A R950m interest rate collar was entered into in March 2006, providing a 3-month Jibar cap at 8.46%.
It is the group's policy to cover all foreign currency exposures arising from the acquisition of goods and services with forward exchange contracts.
In February 2007 we anticipate completing a further securitised bond issuance as the first tranche of our initial issuance matures.
Our dividend policy remains at a cover of 1.7 times earnings per share.
accounting standards
This year is our first reporting period under International Financial Reporting Standards (IFRS). The impact on our results is set out in further detail in note 34 of the annual financial statements. The key changes made to our reporting arose from:
- IAS 39 Financial Instruments: Recognition and Measurement – The requirement that a loss event be incurred prior to recognition of the impairment of a financial asset resulted in a reduction in the impairment provision. Provisioning is a key area of management judgment in preparation of the annual financial statements and we have a rigorous process to ensure the adequacy and appropriateness thereof.
- IAS 16 Property, Plant and Equipment – The annual review of residual values and useful lives gave rise to the reversal of accumulated depreciation, mostly on the property portfolio, where assets may be appreciating in value. It remains our policy not to revalue assets above original cost. In addition we have elected to separate, for disclosure purposes, investment properties not occupied by group companies.
- IFRS 2 Share Based Payments – As previously disclosed, shares and share options issued under our incentive schemes meet the definition of share based payments. The value of the options granted has been expensed over the vesting period.
Of the three standards in issue but not yet in effect which have an impact on Woolworths, we have early adopted IAS 1 – Amendment on Capital Disclosure, and provided a note on the impacts of IFRS 7 – Financial Instrument Disclosures, and IAS 39 - Amendment on Financial Guarantee Contracts.
