Woolworths Group Limited (WOW) Earnings Call Transcript & Summary

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

Good morning, everyone, and welcome to Woolworths Group's call to discuss the demerger of Endeavour Group. Joining me this morning in the room and available to answer questions later are Stephen Harrison, Woolworths Group Chief Financial Officer; Steve Donohue, Endeavour Group CEO; Shane Gannon, Endeavour Group Chief Financial Officer; and Bill Reid, the Woolworths Group Chief Legal Officer. I will open with some introductory comments, and I'll hand over to Steve Donohue and Shane Gannon to provide an overview of Endeavour, and then we will go to questions. While I propose to start on Slide 3 of the document that has been sent out, I'll just start by talking about the fact of the Woolworths Group purpose. As a purpose-driven retailer, it's very important to us that the first demerger of Endeavour Group is consistent with our purpose of creating better experiences together for a better tomorrow. What we mean by together is how we work in partnership with each other, our partners and communities. So while we intend to separate the business, I can't think of a better example of better together than the ongoing partnership that we expect to have with Endeavour Group. Just turning to Slide 4. You will recall that shareholders had previously voted to approve an internal restructure, which facilitated the merger of Endeavour Drinks and ALH to form Endeavour Group. This step was completed on the 4th of February 2020. The separation of Endeavour Group through a demerger is the final stage of the process. It was initially delayed due to COVID, but we formally reinitiated the process in February. And thanks to the extraordinary efforts of teams across Woolworths Group and Endeavour Group, we are in a position today to confirm that we expect Endeavour Group to be trading as a stand-alone business by the end of June. On Slide 5, you will see a slide that we used when we announced the potential separation of Endeavour Group in July 2019. And we continue to think that the rationale for the demerger is strong with the win-win partnership at its core. We expect Woolworths Group and Endeavour Group to benefit from simplification, increased brand clarity and the ability to focus on areas of future growth whilst relevant for each business. We will work to continue to retain the benefits of the leading infrastructure built by the combined group over a number of years and partner in areas like joint food and drinks offerings, Everyday Rewards and data and analytics. I will talk a little bit more about the partnership agreements we have in place shortly. Turning to Slide 6. The demerger will create 2 leading ASX-listed companies with Woolworths Group expected to remain a top 20 ASX company and Endeavour Group expected to be a top 50 company. Post demerger, Woolworths Group will remain Australia and New Zealand's leading food and everyday needs business. We are privileged to have some of Australia and New Zealand's best known and most trusted brands, and we operate and are growing in resilient markets. We're investing in building key capabilities for the future and have a strong balance sheet, which provides us flexibility to deliver value for our shareholders. I will try not steal Steve Donohue's thunder, but investors in the Endeavour Group will be getting access to Australia's leading drinks and hospitality business with a portfolio of incredible retail and hospitality brands and products, a legal and social licensed top brand and run by an experienced management team. Just in terms of the mechanics of the demerger as laid out on Slide 7, Woolworths Group shareholders will receive 1 Endeavour share for every share held in Woolworths Group. The total number of shares that are issued for Endeavour Group will be higher than Woolworths Group, reflecting Woolworths Group's and our joint venture partner, Bruce Mathieson Group, each retaining 14.6% in Endeavour Group, a lot of groups there. A vote on the demerger resolution is scheduled for the 18th of June at general meeting. And assuming we receive the approval required, Endeavour Group will start trading on the ASX on the 24th of June on a conditional and deferred settlement basis. Slide 8 highlights the pro forma financial impact of the demerger. While F '20 results were materially impacted by COVID, based on F '20 pro forma numbers, Woolworths Group had revenue of a $53.1 billion, an EBIT of $2.5 billion, with over 172,000 team members and over 1,400 stores. Endeavour Group had revenue of $10.6 billion with EBIT of $693 million with over 28,000 team members and an incredible network reach with almost 2,000 stores and venues. Endeavour's pro forma net debt at the 3rd of January, 2021 was $1.3 billion, but is expected to be $1.4 billion to $1.5 billion on demerger. This largely reflects the drawdown of external debt to replace the existing intercompany borrowings between Endeavour Group and Woolworths Group on demerger. Shane will run through some more detail on the numbers of Endeavour Group shortly. On Slide 9, you see an update on our retail ecosystem, and we've shown this before and at the core of it are our customers' everyday needs. As I said upfront, Endeavour Group will become a very important partner and allow us to extend choice for our customers and at the same time, leverage Woolworths Group's digital data and supply chain platforms and mutually beneficial partnership. One of the differences in the context of this demerger is the number of and the strength of the underlying partnership agreements that are laid out on Slide 10. And what we have done is a combined group has built strong capabilities across a number of core competencies through material investments over a number of years. We want to preserve the benefits of this capability and investment for both groups with ongoing win-win partnerships. We have partnerships, key agreements in place across supply chain and stores that relates to, in particular, the attached stores, but there's also facilities management that supports that. Loyalty and fintech, which is a focus around Everyday Rewards and WPay and also our WISH Gift Card business; digital and media, which is focused around provision of e-commerce services via the woolworths.com.au website primarily, plus some of the marketing support agreements; business support, which is focused around, in particular, the underlying IT platforms that Endeavour Group will leverage and assure the minor agreements; and the last set is international, which really has 2 components to it, the sale of Pinnacle products to Woolworths New Zealand, and also some export partnerships we have in providing a shared platform in key markets such as China. I'm sure I'll get some questions coming back to the partnership agreement, and we're happy to go through them then. Then just keeping us moving. On Slide 11, I wanted to address what the demerger means for Woolworths Group's balance sheet and capital management considerations. Through the repayment of the intercompany borrowings as at the 3rd of January 2021, Woolworths Group had a net cash balance of $75 million on a pro forma basis. Our pro forma lease liability as of that date was approximately $12 billion. We expect the group's operating cash flow and cash realization to remain strong, and we don't anticipate any changes to our credit rating targets or dividend policy. Following the completion of the demerger, the Woolworths Board will consider Woolworths Group's capital management options. Subject to training conditions and Board approval, $1.6 billion to $2 billion could be returned to shareholders. Further updates will be provided when a decision has been made. Finally, on Slide 12. In summary, we believe that a demerger is the most value-accretive path to separation for shareholders. We are confident that Endeavour Group has strong foundations for success and growth as an independent company. I would now like to turn over to Steve Donohue, to give his overview of Endeavour Group. Over to you, Steve.

Thanks, Brad. I'd like to start today just by thanking everybody for their interest in the Endeavour Group demerger. As I personally work towards my 30th year as a retailer and more recently, a hotelier, I do feel very privileged to be leading such an outstanding team. I'm pleased to share some details of what Endeavour Group is and our continued opportunities to grow as a strong stand-alone business in a new partnership with Woolworths Group. So if you start on Slide 17, before I jump into the details, I just wanted to highlight the importance and purpose for us as an Endeavour Group team. Being purpose-led has been an important part of the Woolworths Group journey, and I believe it's the key to success of any organization. At Endeavour, we are led by our purpose of creating a more sociable future together and the bookend words creating together a really important reference to the history of our organization, one which is built on an entrepreneurial approach to business, always grounded in the knowledge that we're part of the communities that we serve. One of the very important learnings in the Woolworths experience has been that a purpose has to come from our team, not be imposed on them, and that's certainly true for this one. When we talked to our team, they talk a lot about how they connect people through the products we provide and how we connect people with -- how we connect with customers in the places where we work, all in a pursuit of enabling grand experiences. And I saw that first-hand again myself on Saturday night, calling into the Crows Nest Hotel here in Sydney, which was a live example of people enjoying themselves while being offered great service. And I also saw it again yesterday on Mother's Day with the family having a picnic next to us in the park and they were enjoying a glass of red from Chapel Hill, part of our portfolio of brands. So our purpose is alive in both our team and in the lives of our customers that we serve, which I think is very powerful. Another point worth noting is that the device we associate with the Endeavour Group brand, The Circle, represents the imprint that a bottle leaves behind when it touches a surface. A reminder to -- for us that as a team, we acknowledge the importance of our personal imprints on one another and the communities we serve, and we strive every day for that to be a positive imprint. Just stepping forward to Slide 19, the Endeavour Group's leading drinks and hospitality business. So we're a team that are charged with being the custodians of market-leading brands like Dan Murphy's and BWS, well-known to you all, I'm sure, as well as over 330 local hotels across Australia, places that our customers refer to as their own, whether it's my Dan's or my BWS or my pub. And when combined, all of these places represent Australia's largest retail and hotel network, underpinned by digital capabilities, which enable deeper connections with customers, powered by EndeavourX, and also the thousands of drinks products that we produce ourselves in the Pinnacle Drinks business. We're at our best as a business when we combine all of our assets into a single compelling customer offer. That is when we can get a BWS and/or a Dan Murphy's on the same real estate as a hotel or Woolies and when we activate with great products and digital capabilities. We have a proven track record of generating some of the best, if not the best returns in the retail drinks and hotel segments, which I believe provides a compelling investment rationale. Notwithstanding the challenges of COVID in the past year, our combined business continued to deliver with hotels quite effectively and somewhat surprisingly emerging from lockdowns. While the retail side of the business enjoyed upside benefits that they're cycling now, noting that challenges remain given short-term lockdowns in some markets and the current restrictions in New South Wales. We've sustained a long-running expansion of the retail network, while continuing to improve existing stores. And whilst the expansion of the hotel network has been somewhat more subdued in recent years, we do have strong capabilities in improving our existing hotels with a real focus on each local market. Leveraging the network effect of the group and driving efficiencies has allowed us to grow sustainably. We're a large group with more than 28,000 team members present in just about every Australian community. Living and working in those communities requires real effort and investment to live our purpose and deliver market-leading practices with the responsible service of alcohol and gambling services. Here, we've maintained a consistent leadership position by investing in supporting our team with training, partnering with other organizations and investing in technology. We're also proud of the efforts that our team have gone to keep each other and our customers safe during COVID events. In particular, our hotels team have experienced many [ thousands of regular ] visits and only received 2 minor infringements for social distancing standards since the pandemic began. Shane will talk in more detail to the numbers. But in broad terms, our F '20 combined financial performance was strong at a revenue level, but profitability was impacted by the COVID effects on hotels. As Brad mentioned, we generated $10.6 billion in sales and $693 million in EBIT, with a swing from the usual 60/40 mix of EBIT generated by retail versus hotels to something closer to 80/20. The natural hedge between retail and hotels has played out relatively positively for the group, as we continue to navigate localized short-term lockdowns and other COVID-related restrictions. Both the retail drinks and hospitalities markets have demonstrated stability over the long term, up to the point of COVID-related impacts, which we believe will normalize through -- into the future. Our digital platforms have already become the front door to our businesses in the retail space, and that will similarly play out in hotels. We now have a greater number of digital connections with customers than we do physical visits to stores each month, and the hotel experience is increasingly enabled by technology for bookings and ordering in venue. Our business has been built on the strength of our partnerships with a wide variety of partners that have helped enable our growth. And the partnership agreements with Woolies will do the same. They're key to providing continuity of connection with our joint customers through the stores, loyalty and digital agreements as well as providing services on commercial terms in areas such as supply chain and core technology. So I wanted to step forward on to the topic of the areas of future growth for us, so that's Slide 30, and starting with the continued growth of digital engagement customers and the returns that we generate from an e-commerce standpoint. It's worth noting that in retail, e-commerce -- in retail e-commerce, we slightly undershare relative to our share of bricks and mortar. So we've really accelerated investments in digital, particularly over the past 2 years. We intend to continue to invest here with a focus on activation of the suite of digital platforms operating across both hotels and retail. As shown in the pack, the retail business has a history of network expansion, driving solid year-on-year growth. And we're expecting to finish the current year having added a further 35-plus stores. In fact, we are not far away from 1,400 BWS stores and we'll have our 250th Dan Murphy's opened before the end of June. I think a great example of our partnership with Woolworths is that our upcoming new Dan's at Kirrawee will have a shared customer drive-through pickup facility enabled by our respective apps. We continue to grow our retail network as well as it is enhancing the existing footprint. Firstly, in the retail offers with new capabilities injected from our specialty businesses and new formats, including the 2 neighborhood Dan Murphy's stores we now have in Sydney and the Gold Coast. We'll also take a disciplined approach to accelerating hotel acquisitions where opportunities represent a good fit with our network and capabilities, and of course, we have the opportunity to accelerate the hotel fleet renewal. A large part of historical growth and certainly key to the future growth -- our future growth will be our continued ability to respond to emerging product and consumption trends in order to meet customers' needs. This is true across both retail and the hotels business, and importantly, is increasingly driven by the depth of our customer understanding through our digital platforms. The insights from which are applied by all of our teams across the group and drive things like new ranges and new store layouts, the recent resurgence of Rose Bay in our stores and our leadership of the emerging seltzer category being 2 current retail examples. Whereas in hotels, whilst we are very locally focused, we've also taken a group-wide 3-tiered approach to our Nightcap branded accommodation offerings, reflecting customer segmentation. Another area of historical focus for the group and certainly a feature of our new growth will be our ability to enhance end-to-end efficiency throughout the business. There's been a lot of work done across both hotels and retail in recent times, but it's also true that these 2 parts of the group only came together through the merger of retail and hotels just over 12 months ago. So we'll continue to focus on areas where synergies can be unlocked, in particular in digital, but also across other parts of the business, leveraging our scale and making considered investments to drive efficiency. So overall, I feel confident that we've got the capacity to grow our business through a variety of levers. And one of the other things that gives me great confidence is the quality of the team that we've built, and it's particularly good to have the support of Shane Gannon as our group CFO, who's only on his second month with us, having joined from Mirvac. So welcome Shane, and I'll hand you now to step us through some numbers.

Okay, thanks, Steve, and good morning to you all. While I've only been in this role for a relatively short time, I'm very excited to be involved in the journey of Endeavour Group to becoming a successful listed company, and I am looking forward to being part of the team responsible for delivering significant value to our shareholders. As you have heard from Steve, under Woolworths' stewardship, the Endeavour Group has become a very successful company, with market-leading brands, an extensive and fast-growing digital footprint, a unique portfolio of high-quality assets and an impressive track record of value-creating growth over a long period of time. At a headline level, the business has continued to demonstrate strong growth and EBIT margin generation, even in challenging times such as COVID. We have a strong cash generation profile, which will provide the flexibility to fund dividends to shareholders as well as support historical CapEx investment levels of over $300 million annually. It is worth noting, subject to Board approval, it is our expectation that we will pay a dividend for the 6 months ending 30th of June 2021 in the first 6 months of the 2022 financial year. Now turning to the pro forma financials. As the periods covered by the pro forma financials have materially noncomparable factors in each year, I will provide some context in their next slides in order to increase the available insights. Endeavour generates a bit over 80% of its sales from retail and 20% from hotels. However, it is worth noting the 2 are sometimes interconnected where retail and a hotel are co-located on the same site. In terms of EBIT contribution, hotels over-index with an EBIT margin of around 15% and retail at around 6%, which is market-leading relative to competitors. Over the last 3 years, the Endeavour business has delivered solid revenue growth, which has continued into the first half of the 2021 financial year. And as you will have seen from Woolworths' recent Q3 trading update, that momentum has maintained in the March quarter. The EBIT outcomes in each year are characterized by some unique factors that complicate comparisons, so we'll take you through these at a high level to provide clarity. FY '19 saw a step change in investment in a number of critical areas for Endeavour's future performance, including digital platforms, data and analytics, customer experience and retail range optimization. This was the year in which we launched EndeavourX. We have been growing e-commerce at double-digit rates, which is a strong contributor to our retail performance during COVID, and we saw a big shift to online sales. However, the additional costs incurred has put some downward pressure on margins. Our hotels business also came under cost pressure in FY '19, particularly in the first half, which saw weaker trading conditions contributed to an under-recovery of fixed costs. This improved the second half of FY '19 and flowed into FY '20 until the impacts of COVID were felt in half 2 of FY '20. Fiscal year '20 was a year of 2 different halves and 2 businesses pulled in opposite directions during COVID. The first half of the financial year was relatively soft in retail, with drought and large-scale fires over the December, January period, causing nationwide disruption. From March, COVID caused a nationwide shutdown of hospitality, impacting the whole hotel portfolio, materially reducing EBIT due to the inability to fractionalize fixed costs, substantiate core team lease costs and depreciation. The COVID retail sales surge was accompanied by a premiumization trend and softer price competition, which improved GP margins. This was partially offset by the higher cost of e-commerce sales, higher staffing levels to support in-store demand and buyer-specific related costs such as PPE. This continued through first half of FY '21 with hotels reopening gradually under restricted trading conditions and the second wave lockdown closing the state of Victoria for several months. Now with respect to outlook heading into FY '22, we expect hotels to continue to recover, subject to the easing of trading restrictions as COVID risks abate. Retail is expected to return over time to pre-COVID levels, having a short-term negative impact on retail sales growth year-on-year. However, we are confident that the accelerated shift to e-commerce we saw during COVID will be sustained, and we will continue to invest in our offerings, which also seek to optimize efficiencies. Next slide, pro forma balance sheet. As you can see from this slide, as of the 3rd of January, 2021, Endeavour had a strong balance sheet, which will help support ongoing growth initiatives. Our intangible assets include $2 billion of liquor and gaming licenses, which underpin our license to trade, and they're a core source of competitive advantage in a tight regulatory environment. Our freehold assets include properties from which we believe there remains development opportunities. Our pro forma net debt position at 3rd of January 2021 was $1.3 billion, excluding the lease liabilities. This is a cyclical low level of net debt immediately following the Christmas peak trading period. Before the payment of trade payables attributable to Christmas stock buildups. The next slide on pro forma cash generation. It must be noted that the pro forma cash flows have been constructed from what was a deeply integrated balance sheet with the Woolworths Group. And so it's illustrative only. In addition, COVID trading and retailers generated a consequent surge in cash flow. Regardless of these issues, I'm confident in saying that one of the strengths of this business is its strong cash flow generating characteristics. We estimate that our CapEx for the 2022 financial year will be maintained at around current levels of between $300 million and $350 million. Turning to capital structure. As part of the demerger process, Endeavour has negotiated new banking and term loan facilities separate from those operated by Woolworths. As of listing, Endeavour's net debt is expected to be between $1.4 billion and $1.5 billion, which is a level which we are confident that can be comfortably serviced based on the current business and financial settings. Post the demerger, one of our priorities is to achieve credit metrics which are consistent with an investment-grade profile. Our first dividend payment is expected to be for the first 6 months ended June 30, 2021 and in the range of 70% to 75% of NPAT. Notably, the new Board -- Endeavour Board will have discretion to review this policy over time. So in summary, Endeavour is in a strong financial position. We have momentum in our existing business, which we expect to continue into the 2022 financial year. We expect the business to continue to generate sufficient free cash flow in the coming year to deliver a balanced approach to funding CapEx in line with 2021, to reward shareholders by paying appropriate dividend and to make steady progress towards achieving an investment-grade rating. Thank you, and I'll now hand back to Steve for a few concluding remarks.

Thanks, Shane. So just briefly to close before I pass back to Brad, and we open up for questions, we're feeling positive about taking Endeavour Group forward as a stand-alone company. We're focused on continuing to enhance and grow our businesses and deepen our understanding of customers to better meet their needs. Through a combination of our ecosystem and our partnerships, we can focus on stability through the demerger. We will benefit from continuing to be purpose-led and aim to drive strong financial outcomes as a group. Thanks. Brad?

Thanks, Steve. Thanks, Shane. Without any further due, we'll turn the floor open to questions. [Operator Instructions] So over to the questions.

[Operator Instructions] Your first question comes from Grant Saligari from Crédit Suisse.

Brad and Steve, and thanks for the opportunity. And yes, it is a very good day for Woolworths and Endeavour Group. My question, Steve, if I could, is just if you wouldn't mind expanding on the return on capital profile of Endeavour Group. I mean, it is fairly obvious in the numbers over a long period of time, Endeavour generates a significantly lower return on capital than the supermarkets business. But it would be interesting to get from you some color as to why that is the situation and sort of some of the puts and takes in that, and why you would feel confident that you would get better returns, I guess, from some of the reinvestment opportunities that you talked about, whether they be retail or whether they be hotel acquisitions or redevelopment. Because at face value, it looks like the return on capital is being stacked at a certain level for sort of a fairly long period of time.

Thanks, Grant, and congratulations or whatever the right expression is for your new role. Let me make some introductory comments and then turn the floor over to Steve. If we look at our return on funds employed, that is very strong across the group, in particular, if you look at the way our working capital -- our weighted average cost of capital has evolved. And so both businesses generate, we think, very good returns, way above WACC and certainly above aspirational hurdle rates as well. They're quite important, I think, in particular, in the context of Endeavour, it is always to look through some of the goodwill from what assets we've acquired in the past and look at the underlying characteristics of the return because when you do that, you see a much better picture than you might do if you leave the goodwill in there, which is obviously a legacy issue, but shouldn't confuse future investment decisions, which can be much higher depending on whether they are organic, of course, versus M&A. So we see -- and from where we sit as an owner, historically and as a partner and as a shareholder going forward, we see a very strong spread between the return and the weighted average cost of capital, in particular, if you adjust for them both. But I'll let Steve talk to some of the opportunities that they -- that the group sees to continue to grow value for the group going forward.

Yes, thanks, Brad. And Brad is right, the carrying value of license is material on our balance sheet, and that has an impact on the overall ROFI, but we're a licensed and regulated business, so it's also an important asset that enables the business itself. I think if you look at, as I said, in the markets we operate in, in the retail drink space, in the hotel space, we think we deliver above-segment returns. When you look at the actual component parts, we get very strong returns from our digital investments, first up, and that's why that remains a big focus for us. The renewal of the BWS fleet has been something we've been very focused on over the last few years, really important for us, given the chance of that sort of falling out of fitness, if you like, being such a big network, but we're in a really good place there. And our BWS renewals have traditionally provided us very strong returns, which is why we've had a lot of focus on that part of the business. Dan Murphy's, a lot of the returns that we've got out of Dan Murphy's has been through network growth, and we've only just started to put down a number of new formats. We've just opened our South Melbourne store. And as I mentioned, we've got those 2 smaller neighborhood stores. They are providing us some really interesting insights into the sort of returns we could get out of the existing fleet going forward. So positive opportunities there. And then with respect to hotels, I think we recognize we've got an opportunity to improve the returns in the hotel business. But the hotels that we have touched or renewed over the last 12 or 18 months have delivered quite solid returns. So it does give us a degree of confidence going forward. And I sort of mentioned those all in a bit of a descending order, I suppose, with hotels being an area of real focus for us into the future.

Your next question comes from David Errington from Bank of America.

Brad, this is a question to both of you. On my rough numbers, I mean rough being the operative word, but your net debt-to-EBITDA on a reasonable level, Woolworths, even after if you paid $2 billion out, you're going to be under 3x net debt-to-EBITDA Woolies. But Steve is going to be about anywhere between 3.7 and 4, which means that Woolies, even if you did $2 billion of capital management, you're going to be still under the magical 3 number, which you need to be a BBB+ if Steve is going to be sitting there close to 3.7 to 4. So the 2 -- the prong questions are -- that's a statement. The questions are, one, your Woolies balance sheet, even with $2 billion is going to be under, which means that you could do more capital, but Steve's balance sheet is going to be pretty stretched and going to be reliant upon a significant recovery. However, he's going to be balance sheet constrained for future growth. Now that's my rough numbers. But they're what the numbers tell me, given the numbers that you've given us. So can you give some comments as to is Steve's balance sheet going to be stretched for future growth? And two, after this, even with $2 billion, is your balance sheet going to be under, so we can expect some more returns in the not-too-distant future?

Thanks, David, and good to hear from you. You've asked one of the most important questions in the context of what we've announced today. And obviously, it's been a topic of a lot of thought, conversation, analysis across both businesses. I'm actually going to turn it to Stephen Harrison to talk through how we've worked through it and why we think places, both businesses in the right position to succeed going forward. But I think Steve started with some context and color to where we set historically with Endeavour Group and the debt levels inside Endeavour Group, what we've refinanced and how we're going to start thinking about the consequences of that for Woolworths.

Thanks, Brad, and thanks, David. Yes, I think it's worth just giving some historical context. As you know, at the end of December, the Woolworths Group had external debt of about $2.6 billion in a gross basis. And a lot of that's obviously sat in, traditionally the ALH Group and more recently, Endeavour post the merger and restructure. And in fact, the level of debt that you see in that business does reflect the level of debt historically. And I've got to say, actually, the level of debt currently is at 1.4 to 1.5, which is what we're forecasting. At the end of June, would be probably the lowest level of debt that we've had in over 5 years within that business. So it is in the context of these businesses are traded with a degree of leverage for a period of time. Obviously, if you look at the metrics, you are right in terms of the math. And obviously, you've adjusted for looking through F '20, which I think is right. You can't look at the metrics just on a F'20 basis because of the impact of COVID. But we have looked very much at what is the -- a reasonable level of gearing for Endeavour, but in turn that has the capacity to service debt, continue to pay a good dividend and also invest to grow and our view is, and you should ask this of Shane as well. But our view is that actually, with these current settings, the Endeavour Group has good access to capital and will be able to support future growth. And then in terms of how we thought about the Woolworths' balance sheet in a post demerger environment, obviously, we've looked at a number of considerations. So what are our balance sheet and credit settings, what is an appropriate level of headroom for us to have to fund the sustaining of the business and continuing to grow the Woolworths Group. What are our external levels of debt and should we pay down debt, that's something that we looked at, but actually we looked at the cost of debt and the cost of some of those decisions. And we don't think that that's necessarily the right level. And you point out, we've got capacity within our credit metrics to continue to return funds to shareholders. So that's why we flagged actually the opportunity post the demerger and post completing all the processes in terms of the tax office, really, et cetera, the opportunity to return funds to shareholders which we signaled at that $1.6 billion to $2 billion, we're just looking to flag that action in the second half of this calendar year. And so ultimately, we feel comfortable with where Woolworth group is at in terms of its credit metrics and its balance sheet settings. But equally, we're very conscious that the shareholders of Woolworths today will be the shareholders of Endeavour tomorrow, and we want to make sure that there's an appropriate level of balance sheet settings for Endeavour to support its future growth.

So I mean, in summary, David, I mean, we've tried to balance the two, as Steve has talked through most of the considerations we've put into the balance.

And is Steve happy with the balance sheet of Endeavour, right?

Well, I'll turn to him to speak for himself.

Yes, David, I support everything that Brad and Steve said. We are feeling confident about our abilities going forward to grow our business and what that will mean for our cash flow. So as Steve Harrison pointed out, has -- it just reflects the traditional level of debt that Endeavour has carried whilst we've been part of the Woolworths Group. So yes, we feel confident.

Your next question comes from Ross Curran from Macquarie.

Steve, I was wondering if you could help us understand a bit better the hotels business, but specifically gaming and how important gaming will be for the Endeavour Group going forward. You're going to end up with 1,200, roughly, poker machines, you have 290 TABs, 250 KENOs. Are you happy with the poker machine fleet? I see you've only been replacing 11% of those machines per annum. Do you need some catch-up CapEx across the poker machines and gaming more broadly?

Well, thanks, Ross. I'll let Steve talk to how we're thinking broadly around hotels and the go-forward and the capital profile, which sort of does come back in a way to the question that David posed. So Steve, over to you in terms of where you're thinking about CapEx in hotels and the role of gaming in that?

Thanks, Brad, and thanks, Ross. A small correction, it's 12,000 gaming machine entitlements, not 1,200. So it is a big number. Yes. To Brad's point, we do have an opportunity to think probably more deeply about the way we're renewing our hotels fleet. As I mentioned in my remarks, there's this very nice benefit that we get from developing a BWS or Dan Murphy's on the hotel side. So that's going to continue to be a feature of the hotel property asset development into the future. But the hotels themselves, I think, really interesting in terms of their component parts. You're really talking about a bar offering, a multiple bar offering, a food offering in the bistro and gaming as well as accommodation, which has actually been, notwithstanding COVID challenges, an interesting part of the investments we've made in recent times. You're right to focus on gaming now in terms of the cycle of investment. It is -- the gaming machine category is very similar to a lot of categories that are operated in both the drinks and food business in terms of the need for us to keep it current and relevant and focused on customer trends. It has a fashion element to it, like a lot of categories do. And the life cycle of all technology is shortening, of course. So I think you're right to point out the historical rates at which we've renewed our gaming machine fleet. There's probably an opportunity for us to step that up marginally. We're not talking about any major shifts. But just in terms of trying to keep current with the expectations of patrons when it comes to gaming would be an area of focus for us in the future.

Your next question comes from Ben Gilbert from Jarden.

Sorry, another one on the hotel side, because it seems like it's sort of the real opportunity in the group. Obviously, the liquor side is performing very well, too. Just could you give us any feeling around sort of what sort of returns you'll be targeting on CapEx for the fleet? And maybe Steve, just what the average age of the fleet in terms of what's been touched. So [indiscernible] times, whatever, 7 years, how the hotels are looking. Just trying to sort of put some numbers around what we could think about the output as you put more CapEx into that part of the business.

So Ben, I assume you're talking about hotels in your question.

Yes, yes, sorry, Brad. Yes.

Sounds good, okay. Well, I'll let Steve work through and give you a sense of where he's going on that. Just one caveat, which I think is really important. In the whole topic of renewal, age is becoming increasingly hard to measure because you tend to touch different parts of a site, whether it's a venue inside ALH or even a supermarket at a different frequency. And therefore, you sort of blend it out, so you might touch something over 7 years, but actually you don't touch it once every 7 years, if you know what I mean. So it's actually becoming a very hard metric to comment on specifically. But I'll let Steve talk to where the state of the venues are and how you're thinking about investment back into them.

Yes, thanks, Brad, and thanks, Ben, for the question. Brad's right. Increasingly, it's about how much the venues being sweated, if you like, so the footfall through rather than the age thereof. But we do look at both, and that increasingly will feed into our plans in terms of the renewal opportunities that we target. As I said, when I was sort of trying to describe the IRRs we get from our various capital initiatives, hotels does have an opportunity to improve. But the hotel renewals that we've done in recent times have given us cause for optimism as to the extent to which we can continue to improve and the fact that it already delivers well above our risk-weighted cost of capital. So we feel positive, I suppose, about our capacity to do it. I won't give you a specific number, but suffice to say, it is -- it does offer us positive returns. Another point just worth noting is we have this propensity as a finance team, I'm including myself in that somewhat, to try and disaggregate our hotel and retail business. So you've got a Dan's on a site with a pub. We're sort of narrowing down, trying to understand the returns from gaming, and separately, the returns from the bistro, for example, when in fact, all of them are interrelated. So as I said again in my opening remarks, a lot of the benefits that we get are from the aggregated sort of numbers. So we spend a lot of time trying to pull them apart and then put them back together, all in pursuit of building the best local pub we can and activating the optimum retail offer associated with it.

It's a funny one, Ben. Just in general, there's a lot of sound and furor that goes on inside Woolworths around return on capital, but we're sitting invariably with opportunities that are 10%-plus. And our issue is really executing more than if there's anything else. And that's in the context of a weighted average cost of capital that has trended down, and you would have seen in the documents, the cost of financing the debt into Endeavour Group, which is well under 200 basis points as you'd understand. So our real challenge as a collective is generally being and continues to be where the Woolworths Group or Endeavour Group actually executing well, not necessarily the underlying return we get. And we've started the renewal journey in supers than it was into BIG W. To Steve's point, we really have seen some great points now in Dan's, but being a bit more creative. So what it is we're trying to do in Dan's, whether it's a small one or a real up one that is in South Melbourne and the same forensic attitude is now starting to be applied into the venues, which is good. And we saw today and in the future, we'll be sharing learnings and capabilities of format and renewal across both businesses on a go forward.

[Operator Instructions] Our next question comes from Andrew McLennan from Goldman Sachs.

One, I just wanted to know if there's been any major impact to the franking credit balance post the transaction. And if you could also rule out the dual-track process.

Thanks, Andrew. Good to hear from you. So the first bit was on the franking credits. We might just need to come back to that, make sure I understood the second, but I'll let Steve Harrison just talk to the franking credit question.

No, Andrew, and appreciate, we put a lot of pages out for you to read, but at the end of December, franking credits within Endeavour Group were in the magnitude of $600 million. And that is just a function of the fact that within ALH prior to the merger and restructure, it effectively set outside the Woolworths tax group and therefore, had its own franking credit balances for the tax paid.

And has that, therefore, made an impact on the sort of the magnitude of the potential capital management within Woolworths?

No, that's been a separate consideration. We've looked at that much more through the lens of what is the Woolworths Group need moving forward and what are our appropriate credit settings at the right level of headroom. So that's -- I mean, it's not been a key driver of that consideration.

Okay.

And do you want to clarify that question back for Brad on -- I think you were asking us dual-track process.

Yes. No. I assume it's a pretty obvious answer, but just wanted to confirm that there's been no further progression from the potential corporate sale process.

I can't hear you very well, Andrew, but let me assume that you're talking to the dual-track process and whether we're still considering it. I think you can see in the documents, there's been a lot of conversations between our joint venture partners, at the Endeavour Board and the Woolworths Board. And as we sit today, our recommendation is to proceed with the demerger, and we're hoping that would urge our shareholders when the vote comes from the 18th of June to support that proposal. And that's balancing a whole range of considerations for what we think is in the best interest of our shareholder on a go-forward basis.

Your next question comes from Scott Ryall from Rimor Equity Research.

I came on a bit late. There was another call, so apologies if this has been asked already, but I just wanted, Steve, if you can clarify, give me the elevated picture on Endeavour growth. Is the major opportunity that you've got as a separate entity because you've now been able to integrate ALH, and therefore, run them as a portfolio as you've been describing with your answers to a couple of questions. Or is it the fact that the business has received insufficient capital under the Woolworths ownership, which is one of the typical reasons for demerger? Or is there something else that -- in the high-level pitch that you'd give to shareholders to retain their stock post the merger that you think I've missed there?

Well, Scott, let me just start, if I may, and then pass it over to Steve. We have -- we're talking about the various aspects of this transaction since June 2019. And in the document we sent out, there are many stages to it, all which collectively layer up to the wide tiers of benefits. One of them clearly was in our stage 1 -- oh sorry, in Stage 2, was the merger between ALH and Endeavour Drinks. So you could create one Endeavour Group. And that was a key part of trying to create simplification given some of the duplication that had emerged over time to the way we operated both groups. So we sort of had the elevator speech, I guess, going on for a varieties of ways over quite a long period. So that is one aspect of it. In the document, you'll see a Page 4 and 5 some of the detail for the rationale, but I'll let Steve come back to from where we sit today, what the benefits are.

Yes, thanks, Brad, and thanks, Scott, for the question. I think if you go to the presentation pack and have a look at Slide 30, the point you are making is really the bottom right-hand corner of that slide, talking to enhanced end-to-end efficiency. So sure, you're right, there are opportunities for us to bring synergies to the ALH business and the former Endeavour Drinks retail business, and we're progressing our thinking on how we're going to do that. And there's also a lot of opportunities for investment in technology that is going to help us streamline the business as well. So really, that Slide 30 constitutes the elevator pitch, if you like, in its most succinct form: growing digital engagement, expanding the network and enhancing the existing footprint of stores and hotels as well as staying very close to customer needs, and that's true for both retail and hotels. The deep focus on understanding our customers and reinvesting in our offers in our -- both our stores and hotels so as to increase their propensity to return to our business is really the flywheel of where we'll focus our investments going forward.

Thank you. Your next question is a follow-up Grant Saligari from Crédit Suisse.

Well, actually, just 2 follow-ups, if I could. Just one on the freehold property in Endeavour Group at $600 million or just below that. Could you give some sense as to what proportion of that is in hotel freeholds that might be available for redevelopment versus sort of other property that might be, for example, upstream in manufacturing, vineyards, et cetera? I think that would help understand the opportunity.

I'm not sure I fully follow the question, Grant. Do you mind just repeating the last?

Okay. I'll try again. You have $600 million of freehold property. I was wondering whether you could indicate basically where that -- what type of property that is. So the proportion of might be sort of hotel freeholds versus sort of, as I said, manufacturing or vineyards.

This is Steve, yes, got it. Yes, yes, sorry, Grant. Yes, yes, sorry, grant, thanks. It's predominantly pubs, there's only a handful of retail sites that are included in that number. So they do represent opportunities. The primary focus for us is to deploy the existing assets and capabilities we have in terms of hotels and retail, but we will be thoughtfully on the track about other development opportunities.

Okay, and just one other follow-up, if I could. Just on the net working capital balance. You did mention that payables obviously elevated in the first half accounts given Christmas trade. Could you give us a sense of what a more normal period end net working capital might be or what bridges throughout the year just so we get a sense of sort of how much sort of extra cash there might be in net working capital?

Thanks, Grant. I'll turn to Steve, Steve Harrison, just to talk about the working capital position. Over to you, Steve.

Yes, Grant, just some color. Obviously, Woolworths operates Woolworths Group and our food businesses operate at a negative working capital cycle, whereas in Endeavour, we have a net investment in inventory over time. So we would typically be in the magnitude of sort of 70 days of inventory. And that may fluctuate but that sort of reflects inventory across our stores, our DC network, Dan Murphy's seller program and equally some of our Pinnacle owned brands and some of the wine inventories that we hold through the cycle. We typically run payables in the mid-40s. So you are looking at a net investment in working capital, indeed a low point -- sorry, net investment inventory. It is a low point in December just because you typically buy a lot of stock. You sell it through for Christmas and New Year, and then you sit on the payable at December, and so that would unwind. And I think that's reflected in partly our signaling of where the net debt was at the end of December, which is around 1.3-ish, and it's more in the 1.4 to 1.5 range expected at the end of June. And I think that -- a lot of that reflects that shift in working capital cycle over time over that half period.

Next question comes from Phil Kimber from E&P.

My question was just -- and apologies if it's buried away in the documentation. When we think about going forward, are there any like dissynergies, stranded costs, extra costs that we should assume? Or do we just simply take what we had previously been forecasting for the division as part of Woolworths and that's a good guide? Or is there actually some costs that we should think about that will occur upon separation?

Thanks, Phil. There are the direct standup costs that you will see called out in the document of Endeavour being a separate listed business, and you can see the number of just under 50 -- I think it's $47 million before that. Then what we've done with the partnership agreements is be very thoughtful to make sure that both businesses can leverage the infrastructure to Woolworths Group. But in the short term, also said what could otherwise be seen as stranded costs. Now in the partnership agreements, if Woolworths Group does not perform in line with expectations of Endeavour Group, those partnership rooms have the ability to be unwound, and they should. And that could cause some challenges down the track for Woolworths Group, but that would be entirely of its own making in terms of its performance level for Endeavour Group. And if there was, there would be an ability, over time, there would be enough time in any of the unwind for Woolworths Group to adjust how it manages costs in the context of the service provide. So no, there aren't anything material. Steve Harrison, I'm not missing anything?

No.

Your next question is a follow-up question from David Errington from Bank of America.

Brad, this is a difficult question to ask, but a very important one, and it's on the makeup of the Board and also the corporate governance. I've tried to work out Colin Storrie, what his position is. Is he going to remain on the Board? Or what's he going to do? And then I suppose the question is, is it appropriate? I know that the Mathieson Group have been outstanding contributors to this group and created a lot of value. There's no question about that. But it is going to be a public company now. It is going to stand on its own 2 feet. Is it appropriate that you've got a father on the Board and a son managing the hotels group? How are you going to manage that? How is Steve going to manage that situation? And what went into the consideration of the Board?

Thanks, David. A really important consideration. Let me just go to the facts and then we can come back to some of the other questions. What was agreed very early on in this process is that given both the BMG and Woolworths Group will hold 14.6% of the business, each business would nominate 1 non-independent director onto the Board. In the case of Woolworths Group, that is Holly Kramer. And in the case of BMG, it's Bruce Mathieson, Sr. So that was part of the original agreement that we struck and both have the prerogative of doing that. I feel -- I have mixed emotions on Colin Storrie actually being on the Board because as you will note on Slide 14, he's listed as a non-executive director. And actually, as part of him moving on to the Board of Endeavour Group, he will be transitioning out of a full-time executive role at Woolworths. And he's done an amazing job for us over the last 5 years. So it's rather bittersweet to having sort of there as a director in his own right. We're very pleased for him to do that. He will not completely sever his ties with Woolworths Group and will still continue to be on the Board of Quantum for us, which is so ably help us just change the shareholding. And hopefully on -- and also in the context of the PFD, assuming that deal goes through as our client. So that's Colin's role. And I think I'll speak for Steve Donohue and Peter Hearl as well. Given Colin has been central to the Endeavour Board in its current structure or the ALH Board before that and as actually shared, the Audit committee for that Board for us. Having this institutional knowledge of the Board on a go-forward basis is enormously helpful. The documents also should outline, by the way, David, that there is -- that this -- the Endeavour Group Board is looking to appoint 1 more non-executive director to the Board, and that will take place in the next few months. So that would then give a balance of independence onto the board, which is important. Other points, I guess, I could make on the Board would be Peter has put a lot of time and balance into what you see presented there, and there's been a lot of dialogue, as you might imagine, between Endeavour, between him and the Director-Select and the Woolworths' Board to be comfortable with the balance of it. And each member of that Board has signed an undertaking of being very committed to preserving the independence and objectivity of that Board, and that includes Bruce Mathieson, Sr. I guess if there's a last point, it's good to see another person being the Chairman of the Board because I will then step down officially on the 28th of June, and Peter will take over. So I'll be very pleased to see the independence the rest of the people bring to the role.

And the management of the hotels group?

Well, that is still Bruce, Jr. Look, I mean, we've managed through this perceive conflict for 20 years, Peter. Bruce is committed to independence. We manage it on an everyday basis. Having that operating experience inside the business is enormously valuable to us. As you well know, there's been huge institutional knowledge in Bruce, Sr., and Bruce, Jr. As I can honestly tell you as the Chairman of the Board at the moment, it is something we manage, I think, particularly well. It doesn't mean we don't -- we're not aware of it and don't put in place the right protocols. But it is something that I think it is all imminently manageable. I won't put Steve in the position -- well, Steve, anything you'd like to add?

No, I support your comments, Brad. And just, I guess, David, point you back to your own comments about the track record that both Bruces have behind them and we're the beneficiaries of their knowledge across the group and Bruce, Jr. very ably leads the hotel team, so yes.

Your next question is a follow-up question from Scott Ryall from Rimor Equity Research.

So that was my macro question before and my micro one is just you started talking about your inventory before. I don't know, I can't remember a time where there's been more cheap wine on the market in the channels that I buy through. So I was wondering if that -- if the current operating environment for wine where export markets are difficult, restaurants are not yet back to full throughput. Is that a risk to your inventory position? Or is it an opportunity because of your channels to bring better value to marketplace?

Well, Scott, I'll let Steve talk to it. I mean, conceptually, as a retailer, if you look at our inventory holding and our inventory turns, conceptually, opportunities in the upstream like this are opportunities for retailers, and that's no different whether we're a food or a drinks retailer, but I'll let Steve comment specifically on where we are in on our wine cycle in Australia.

Brad, you would be in a bit of trouble if you held 70 days of inventory, right, as a retailer? So I'm more interested...

First of all, that's the old 24 months. So everything is relative. And if you want to sell some restaurants, your 80 days payment terms. So anything...

I thought you're upset, Brad, but anxious. A very brief comment on the state of the wine market. There was actually some press over the weekend, actually, pleasingly about the quality of [ Vin ] '21, which we think is great for the industry, and we're a material participant in the industry, I might add. So we think that's very positive. You point out some of the pricing fluctuations. Really, the impact of China has had some downward pressure on some of the more premium regions like Barossa, for example, where there have been declines, but you're probably also aware of very strong demand, in particular from the U.K. market, and that's seen a real underwriting, I think, of pricing of some of the more value end of the wine spectrum. Specifically [ Asia ], Southeast Australian prices have held up relatively well when compared to some of those cooler climate very premium regions. And then we also have this interesting situation playing out with New Zealand, and we are a material customer of New Zealand wine, particularly Marlborough Sauvignon Blanc. And we've got Isabel Estate team over there, who do a lot of our very large-scale sourcing for us, but there's actually a lot of pressure on pricing for New Zealand Sauvignon Blanc, predominantly because of a bit of a shorter vintage and a lot of demand coming out of North America. So like all markets and all segments, there's a lot of puts and calls, and it's very much true for the wine business this year, but I'll just reiterate the point about how pleased we are that the Australian producers have had a voluminous vintage and a high-quality vintage this year, so I think that's good news for everybody.

Your next question is a follow-up question from Ben Gilbert from Jarden.

Also just a final quick one for me. Brad, I'm just interested, did the Board discuss potentially lifting the payout ratio for Woolworths Group? Now you're obviously going to have different inventory cycle, different working capital cycle and gearing is obviously looking relatively conservative as was talked to before. Was there any discussion around lifting that payout to sort of 75% to 80-plus type number?

Thanks, Ben. A good question to define sort of the dividend ratio for Woolworths on a go-forward basis. I'll turn over to Steve Harrison to comment on the discussions we've had.

Yes, Ben, there hasn't been any discussion with the Board about changing our payout ratios. It's a long-established ratio of paying out between 70% to 75% of NPAT, which we feel gives that right balance of being able to continue to sustain the business, invest to grow the business, but also give a strong dividend to our shareholders. Yes. To your comments on working capital cycle, whilst we're a negative working capital, ultimately, the cash generation and the move in that we will be having that step change over time. And so at this stage, there's been no discussion about any change.

There are no further questions at this time. I will now hand back to Mr. Banducci for closing remarks.

Thank you, everyone, for joining us this morning and for your questions. We realize there was a whole lot of documents sent to you, so apologies for the nature of the process that. But hopefully, you will find in the detail of the emerging booklet itself or in the management presentation all the details that you need to understand why we think this is the right decision to make for both businesses and why we strongly support Endeavour Group as a separately listed public entity in Australia. Thank you very much and speak to you all soon.

Thank you. That does conclude the conference for today. Thank you for participating. You may now disconnect.