Woolworths Group Limited (WOW) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Woolworths Group Analyst Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Brad Banducci, Managing Director and CEO of Woolworths Group. Please go ahead.

Good afternoon, everyone, and thank you for joining us at short notice. I know it is a very busy time of the year for everyone in the middle of reporting season, and you will have some time -- you will have only had limited time to look at the material we released today. So I'll just do a brief introduction and then go into question and answer. I'm joined on this call this afternoon by our Chief Financial Officer, Steve Harrison. We're excited to be announcing an extension of our strategic partnership with PFD Food Services today, one of Australia's leading players in the fragmented foodservice market. This partnership will give Woolworths Group exposure to the out-of-home food and non-retail B2B markets and is a logical adjacency in the group's food and everyday needs ecosystem. Subject to completion, Woolworths Group will acquire a 65% equity interest in PFD as well as 26 freehold properties for a total investment of $552 million. The remaining 35% of the business will continue to be held by the Smith family. PFD will be run as a stand-alone operation by its successful and experienced management team, with Kerry Smith remaining as CEO. PFD is the #2 player in foodservice in Australia with a share of approximately 11% of an estimated $18 billion market and is the largest privately held foodservice business in Australia. Foodservice is a new customer segment for Woolworths that we do not have any current exposure to. PFD has over 39,000 customers nationally, which it services from 68 distribution centers with approximately 2,800 team members and over 750 trucks. We see material opportunities to support PFD's growth and realize synergies for both businesses. The partnership should allow enhanced store range localization for Woolworths' supermarkets as we continue to look to tailor store ranges to better meet customer needs. We should be able to realize better route optimization, including potentially leveraging Woolworths Group's primary freight capabilities. And PFD will also be able to leverage Woolworths Group platforms like data analytics, digital capabilities and quality sourcing. The transaction represents an EV-to-EBITDA multiple of 11 on a pre-COVID-19 and pre-AASB 16 EBITDA. It probably won't surprise any of you to hear that PFD's current year earnings have been impacted by COVID-19, given the material impact on a number of its customers. However, we are confident that the out-of-home food market remains very attractive and will recover and continue to grow over time. We expect the transaction to be earnings accretive in the first full year of ownership and are confident that the investment will deliver strong returns for Woolworths Group shareholders. The transaction remains subject to ACCC approval and customary closing conditions, with completion expected by the end of calendar 2020. I will now turn over the call to questions. [Operator Instructions] Thank you again for making the time this afternoon.

[Operator Instructions] The first question today comes from Michael Simotas from Jefferies.

I'd like to try and understand the synergies available a little bit better. And just to put it in context, I guess, 11x trailing EBITDA doesn't feel like you're getting a super cheap price, given the pressure from COVID at the moment. So how big are the synergies available? And you don't seem to have mentioned procurement. Is there much overlap in the procurement of products for PFD and Woolworths supermarkets?

Thanks, Michael. Good to hear from you. It is not -- it is a full multiple, but for the quality of asset that we are partnering with, we have a national distribution, a very strong #2, the best service in the industry, that is a platform that we think could be a really valuable part of Woolworths Group. In the synergy sense, the thing I like about the partnership is that there is no one single overwhelming source of synergy that will define the partnership. There are a meaningful number of ways that we can partner together to deliver value for our shareholders. The most important one I'd call out is our ability to leverage the PFD warehouse and truck distribution network to materially enhance our in-store ranging. We've seen material opportunities, in particular in the premium end of the market to better tailor ranges to local stores. In order to do that, we do need to have -- we need to free up [ fixed slot ] capabilities in our warehouses, which is incredibly challenging for us, or we need to find a third-party to manage it on our behalf. And we see PFD as the ideal partner to help us in that regard. We've for many years that we need -- we would aspire to lead in terms of localized ranging. And while we have a small lead on range, we don't have the kind of lead that we think we should have, and this will materially help us in that regard. So to me, it's the most exciting of all opportunities, how PFD helps continue the transformation of Woolworths Group and the customer experience in our Woolworths supermarkets. And just to keep it in a simple sense, we still have somewhere in the order of 220 DSD deliveries a week going to our stores. It is incredibly problematic for us to manage in a forecasting sense, in a labor efficiency sense. And so just having a partner that we can actually use to help streamline their process would be good for our suppliers, our store team and our customers. So that's the major one I've been really focused on. There are a number of other benefits though. Clearly, we have the ability to help PFD just with leveraging our route -- our distribution capabilities. And we would look to do that just given all the truck movements we have all over the country. So we think that, that will be a material opportunity. We also think that data analytics and just how PFD gets better at data analytics in determining what products to sell to its 35,000 customers, we think there's material benefits there. And the journey we've gone on using data analytics in our business to enhance decision-making, clearly for PFD like with Woolworths, the whole order process is becoming very digital. We feel we have some interesting digital capabilities there as well. Specifically on ranging, what we're actually ranging our Woolworths supermarkets is very different to what PFD actually sells to its customers. So we don't see material benefits in trying to swap the products between the 2 networks that are quite bespoke to target the different customer needs. So we don't see that as a major opportunity. But clearly we have access to commodity sourcing that could be valuable to PFD. Red protein would be a category I'll call out. PFD is not meaningful right now in terms of selling red meat, and it's quite a hard and challenging business to be in as -- for all of us at the moment. But we do have some really fantastic capabilities in assets via our partnership with Hilton meat that we'll give them access to. So some of those commodity categories, we can help them enhance their range of products. Does that make sense?

It does.

The next question comes from Bryan Raymond from Citi.

Just on the broader rationale for this, I'm just interested how much of it is you being able to bring your own capabilities to the foodservice market, and how much of it is using the ability to leverage this into your wholesaling business, your B2B business outside of what you've already outlined on the supermarket side. Is this a broader play on the food market outside of grocery? Or do you think it's simply we cannot add a lot of value to this asset, and obviously there's some CapEx that will be associated with that as you build it over time?

Thanks, Bryan. I'm not certain I understand your question totally, but let me try to have an answer. And then if I don't, please come back and correct me. We're attracted by the nature of the segment that PFD operates in and by the quality of assets and management team it has. At 11% -- it has 11% share in an $18 billion market. So -- and it has a history of growing very strongly in that market. So the ability to co-invest with the Smith family to continue to grow the PFD business segment of service, we think, is a very attractive one. Clearly in the current environment, it's a more challenged segment than it has been for the last 10 years. But we fully expect that the foodservice segment will come back and actually it has been more resilient than we would have expected during the period of COVID, and more resilient certainly against what we thought the forecast might be. So we're attracted by the quality of the business and the management team and the ability to co-invest with the team. And we're delighted that the Smith family will continue to operate the business with their current management team. Secondly though, we do think that what it does is it helps with really leveraging their logistics capabilities to improve the experience in our Woolworths supermarkets, which is not [indiscernible] system. We want to partner with the [indiscernible] to make Woolworths supermarkets a better business because that's where we get real leverage understandably in our system. So we do think there's a lot of things that the PFD logistics capability can bring, I'll say, in particular to the ranges in Woolworths supermarkets and simplifying that business and taking a lot of DSD out of it, which is still very challenging as I was saying in the context of supermarkets that we operate. Now there will be some ancillary benefits maybe down the track as we sort of think about how the world plays out. And -- but those are the 2 key ones I would call out. The rest of the businesses we have in truth, we've got a very nascent small wholesale business that was set up to service, Caltex or Ampol. That's really is diminished. It was really set up in the context of that relationship. And in terms of our e-commerce business in the space, and we've got a slide on it, Woolworths at Work, that really is just a business to better organize those small businesses that choose to shop supermarkets, so not a lot of logical synergies out there at the moment.

The next question comes from Shaun Cousins from JPMorgan.

Brad, maybe just a question more broadly around you started to talk a little bit more about this ecosystem effectively outside of your core food business and the Endeavour Drinks, ALH is sort of part of focusing more on food. But what size outside of food should we think about these new parts of your business contributing to earnings? I mean the current EBITDA of this business pre-COVID, I think, it's sort of 1.5% of your total business. To move the needle, how do you actually -- to move the group needle, how do you actually, I guess, just justify spending money in these areas? Or should we anticipate that these nonfood elements of the ecosystem become, I don't know, 5%, 10% of group EBITDA? Can you just maybe sort of quantify the size of the broader opportunity in the ecosystem?

Yes. Thank you. Thank you, Shaun and it's a great question, and I'm not certain I can do fully justice today. And we might pick it up, I suspect, in our earnings results next week. The keyword in everything we're trying to do is actually not the word ecosystem, but adjacency. And we're really trying to work on building into adjacencies where we can leverage our capabilities into adjacency, but the adjacency also strengthens the core business. And to us, that is the key in all the logic of what we're trying to do. It's not about step-outs into new sectors. It's about building a better overall business by partnering in adjacencies. And adjacencies cumulatively can be very material. Many of them, as we've talked about before, when we actually talked about the demerger of Endeavour, really exist inside Woolworths in some nascent way. What we're going to do is reorganize to recognize them for what they are, and also give them the space, permission space to continue to grow. So sure, we can look at foodservice and say it's quite small. But if you add that together with what we are trying to do with our aspirations in media or with our relaunched Everyday Rewards program, or with the continued growth and re-segmentation of our e-commerce business or some of our partnerships that we have with other foodservice solutions like Marley Spoon, et cetera, it starts becoming material collectively. So we do think it can be material collectively. We do pull some inspiration from what we increasingly see overseas in the space, whether it's the Krogers or the Carrefours or whomever, or even Tesco with what they've done, although it's slightly different to the Booker acquisition. But we think collectively, it is material, but as importantly, it reinforces the core business and makes it a better business. And that's really going to be the key.

And so Brad, when you think material, 10% is a reasonable number for materiality? Or you highlighted it. Is that collectively -- sorry, it's your word, material. So I'm just curious about what do you think about material is.

Well, I mean if -- no, we -- so the 2 different ways to look at it, right, is what percentage of growth comes from it and then what percentage of overall business earnings come from it. And I think it's material in both. It's probably more material in growth than it is in total earnings. But you -- we would aspire for ecosystem at least a quarter of it to be through nontraditional mechanics outside of the traditional four walls of the store clearly, and actually as a percentage of growth materially more than that.

The next question comes from Ross Curran from Macquarie.

I've just got a question on the DCs. What are your plans with the DCs and how they integrate with the existing network? Do you plan to keep all 26 of them? Or is the idea to scale up the [ skeleton ] of those?

Yes. We don't have a detailed plan in this regard at this stage. They've got 68 by the way, 25 of which -- sorry, 25 to 26 of which we've acquired the site itself. The 26 are the key strategic ones. What PFD have, which is relatively unique, is the biggest DC network across Australia and that's highly attractive there in all parts of the country. And it complements our DC network, as you know, with the announcement of our investments and transition to Moorebank. And certainly increasingly, our DCs are very big, very automated. They're fantastic when you get to cartons or pallets. They're not very good when you get to breaking down cartons or really into inners. And this business can complement that in a very important strategic way. It is those extra few products in the stores that you find unique in the store that often a customer will switch for, but are very specific to the nature of the demographic where this business can be driven out through PFD. So they've got a lot more warehouses than we have. They've got a good warehouse management system through Manhattan, but it is very different in that that's not automated. But that makes it ideal, as I say, for inners and not for -- not to build pallets and really does complement what we do today. How many they should have in the future? I don't have a view and I'm not a logistics expert. But I would say the real strength is the fact that it is incredible national coverage. And I'd like to just call out also that they're very strong in frozen, which is a really important category. And having more frozen capacity accessible for us is incredibly important in particular if the COVID crisis continues on.

The next question comes from Phil Kimber from E&P.

The question was -- that I have is just how the economics work. So PFD's customers, you've broken out how they break down. But if we took, say a restaurant, the restaurant is paying PFD. Does PFD actually make its money by actually buying the product, adding a margin and on selling it to the restaurant? Or does the restaurant just pay a delivery fee to PFD? And I guess I'm just trying to understand, are there any situations where actually the customer is really the food supplier and they pay PFD to deliver rather than it being sort of wholesale margin arrangement?

Well, Phil, that's a very detailed question. In truth, it is a combination of models. If you're working with some of the key accounts and some of the key protein lines that go through it, PFD would act more as a distributor. But for a smaller non-chain-based QSR, it would just be really a PFD acquiring and then wholesaling the product through. So it does depend on the nature of the customer. As I say for the big chains, often it is more of a distribution-type scenario on their core lines. And often those core lines are bespoke for them. They've been growing on in whatever form that means that they're unique to the customer concern. So it does vary by customer and by type of product sold. But in general, it's more of a buy-and-sell model than it is a distributor margin model. Does that make sense?

Right. And yes, yes, it does. So therefore, I mean, it needs to have relationships with the food suppliers? Or is it actually just procuring sort of commodity products, and then charging a distributor fee to get it to a QSR or restaurant or the like? Or is it actually going to say Unilever just to pick an example, buying the product, adding a margin and then on selling it?

Yes. Well, I mean I don't know if Unilever would be a good example, given that it is really a food -- it's more -- well, I mean it's a food business. And we work with traditional suppliers. We will have some supplier overlap with very different natures of the products we sell. So they would be doing much bigger packs off, and they would be doing very bespoke products for the channel or the customer. So there are -- we do have some supplier overlap, but very different products bought and sold and very different pickup in trading terms. And we've been very clear when we announced the investment today that we would expect to have great diligence in terms of the Chinese worldwide walls around trading terms for the shared suppliers.

[Operator Instructions] The next question comes from Aryan Norozi from UBS.

Just first one for me, please, just a clarification around the 25% of growth you're talking about for earnings outside of the four walls of the store. So did you mean 25% of incremental growth will come from ex the access stores? Is that what you're saying?

Look, it's one of these topics that we're talking about aspirations versus the budget which we're very focused on delivering for F '21 and which will be 8 weeks in when we talk to you next week. So let's not confuse the 2. But if you look at where a lot of these ecosystems are evolving, it can be actually a material portion of growth that you can access outside of the stores. And clearly e-commerce will the major opportunity, but not the only one. So it can be materially more than that. And then cumulatively, if you start looking at the earnings the right way, it can be up to a quarter. So as a percentage of growth, it can be much higher. As a percentage of earnings, you would aspire to it being meaningful. And I guess that it's not our numbers, but if you -- a quarter would be meaningful and if you're looking at our recent...

Perfect. And just very quickly the customer concentration within the network, is it -- how -- I know there's a lot of [ hustling ] within it, but how concentrated is it from a revenue perspective, please?

It's pretty -- one of the reasons we like the partnership with PFD is it is a national platform, and it participates in a number of different sectors of the foodservice market and also has a very large customer base. And so there's a lot of benefit that come from just being able to spread the risk across that. So as I think we called out, about 35 -- 39,000 customers nationally. It has some big customers, but actually it's a pretty well-balanced business, which is what makes it an attractive partner for us.

The next question comes from Andrew McLennan from Goldman Sachs.

Sorry, I dialed in a bit late, so hopefully this isn't a repeat. But I was just wondering -- and I know the Booker transaction is different because there's sort of wholesale to independent retail [ always ] within that business but in addition to food services. But I'm just wondering, they had quite a bit of problems convincing the competition authority in the U.K. to let that transaction through. I was just wondering when, in relation to the ACCC, I mean how have you considered this from a sort of concentration of risk from a supplier's perspective? I know, Brad, you did sort of skid into this by talking about Chinese walls, but in the end, you may own 100% of this asset. So I'm just wondering how you thought about that because I know food suppliers try to diversify.

Yes. I mean I think obviously in a -- it's 11% share in an $18 billion market that Woolworths doesn't participate in. So in that sense, we would hope that the logic is clear in our engagement with ACCC on our ability to enter the sector. In terms of suppliers, Andrew, the overlap, there is an overlap clearly. But it's not quite as pronounced as you may think, given just the different natures of what we do. And then we're very clear under the grocery code of conduct and under all the learnings we've acquired in the group in the last year is as part of the efforts we put into supporting Caltex in particular or Ampol with food -- with wholesaling that we need to run very -- these are very different businesses with very different trading terms, given the different nature of the business. And we need to respect that, and we need to have very clear firewalls inside the group between retail and nonretail. And that's something we were committed to doing irrespective of this, but we're just doubling down and been very overt on this commitment out with -- actually with suppliers today. And we will be very overt and give whatever account that is required in the context of the ACCC. It's not the -- it's actually -- they're just different. You can't expect, as I say, the same trading terms with a retail solution you're providing for a slide versus a foodservice solution. We know that, and we intend to respect that. That's all I can tell you.

The next question is a follow-up from Michael Simotas from Jefferies.

The DC network seems to be key to your rationale for buying this business. Can you just talk a little bit about the current state of the DCs in terms of the location, the equipment that's in and what sort of investment would need to be made into this network over time to achieve the objectives you're setting out to achieve?

Yes. Thank you, Michael. I'll say a few words and I'll get Mr. Harrison, our CFO, to also add his. What is nice about partnering with a family-owned business is that it's been a business that's been well invested in for many years. And so it is not a business that we think has been under-invested in. In particular, they've been going through quite a large warehouse upgrades in the last couple of years. And that is actually only just coming to completion now. In particular call out the new warehouse they've just transitioned into Chullora in Sydney. But also they've got the new warehouse in Melbourne that I think was ...

In Knoxfield.

Knoxfield, it was about 18, 24 months ago. So we feel it's been a business well invested in. It's not under-invested in. It has got capacity with their moves into the new warehouses. But Steve, I don't know if there's anything you'd like to add.

I think probably the only thing to point out is that in the last 3 years, the family has invested in the range of $100 million in capital to grow the network and also implement state-of-the-art system. So you mentioned earlier the Manhattan Warehouse Management System. So the team visited most of the sites. We think actually the facilities are well looked after. I know there's been family problems among their safety record. And so we think that actually we're buying a network with very good facilities. There will be opportunities to invest and grow that network over time. There's a facility under construction in Queensland at the moment, but overall, we think actually is in pretty good shape.

That will be funded and actually we need to go before probably we get clearance to complete it.

Yes.

The next question comes from Craig Woolford from Citi.

Firstly, just a clarification, so what -- it looks like it's a 2.7% EBITDA margin business. What sort of depreciation could we expect? I hope that's just a short one to take up a tough question. The bigger one is you mentioned about sharing data and other sort of digital capabilities. Does that mean you've got to integrate your systems with PFD?

Thanks, Craig. It's 2 in 1, but I'll answer the second, but then I'll ask Steve then just to elaborate on the margins and the D&A. No, no, no, it doesn't require that. But we, for example, have invested materially in route optimization software both for our home delivery trucks, which is actually starting to really generate great benefits for us. It's an AI-driven system out of the U.K. And we've done the same with -- in our primary freight distribution network with our new transportation management system, which is we've implemented with Blue Yonder or JDA, as it used to be called. So it is actually taking a lot of those capabilities to see how we can help enhance the routing systems of PFD. So it's those kinds of activities. We've done a lot of analysis and a lot of work, as you would know on pricing algorithms, cost to serve algorithms, and so supplying all of those analytics and giving the ability to use those analytics. So it's not about actually merging the data, but it's actually taking things that are increasingly working and material inside Woolworths Group and seeing what value we can add to PFD. As we sort of listen to the series of use cases that they are working on, they feel a bit deja vu-ish for use cases that we had at Woolworths 3 to 4 years ago. And that's not to say we've solved them all, but we're well down the track. And we've got the benefit of having now, we think, increasingly a very good digital and data analytics team that we can leverage to help accelerate their moves in this space. I'll let Steve talk to the margins, the D&A and how that plays through over to PFD.

Thanks, Brad. So Craig, yes, I think just 2 points to highlight. Firstly, all the numbers are presented on a pre-AASB 16 basis. The Smith family and PFD will be adopting that new accounting standard for the year-end, but they haven't yet completed that. So the depreciation and amortization, which excludes lease depreciation, in the range of $20 million per year. So you could just add that or subtract it to get from EBITDA to EBIT.

The next question is a follow-up from Shaun Cousins from JPMorgan.

In regards to this process, was this a competitive process that PFD won? And did Woolworths look at other alternate acquisitions in this space to enter the foodservice market, please?

Thank you, Shaun. We've been huge admirers of this business for a while. It's a really high-quality asset. And we've known Rick for a long time and just admire everything he's done. We actually have been quite a material, a top 10 customer of PFD via our ALH venues going back close to 25 years or in various guises. So we know the quality of the service they provide. We've benefited from that over time. And we were just in the COVID-19 early days, we actually signed an agreement with them to get them to support us, just with some of the opportunities we had to try and do home deliveries. And there was a really good cultural fit in that, and we felt a real -- that we were good partners. And from that and the history of the partnership came this opportunity to do something more meaningful together. It is a partnership in the real sense of the word, I need to emphasize the Smith family will still have 35%. Now there are puts and calls a few years out, but that's just sensible business practice, of course. They are options that don't have to be executed. And Kerry Smith, as one of the conditions precedent, will stay on as the CEO of the business. So we've known them. We respect everything that Rick has done to build this business. Proudly Australia known since 1943, and it was a great opportunity for us to co-invest.

Thank you. At this time, we're showing no further questions. I'll hand the conference back to Mr. Banducci.

So thank you very much, everyone, in the middle of a very busy week for taking the time to speak to us this afternoon. We look forward to talking with you further next Thursday when we release our F '20 financial results. So I really appreciate you for being flexible this afternoon.