Lockdowns drive fresh growth for Woolworths shares

Despite the uncertainty of ongoing lockdowns, a continued focus on sustainability and strong fundamentals is resulting in favourable returns for Australia's largest supermarket retailer, Woolworths Group (ASX: WOW).

From a total return perspective, Woolworths has outperformed the index in four of the last five years, providing a consistent, fully franked dividend and solid capital returns.

And this year has been no different. Last month, the group announced an increase of its final dividend to $0.55 per share, an increase of 15% from the 2020 final dividend.

Employing more than 200,000 staff in 3000 locations across Australia and New Zealand, the group's financial year 2020/21 revenues (from continuing operations) rose 5% to $55.7 billion and profit rose 20% from $1.25 billion to $1.5 billion. Much of this growth was recorded in the first half of the financial year, reflecting the high proportion of people in lockdown across both operating countries.

Management's ongoing focus on sustainability is key to the stock's attraction for investors.

A good indicator of management taking an appropriate longer-term view beyond the next six to 12 months is its commitment to 100% solar power by 2025. Of course, at a time when all things decarbonisation are front and centre, there remains room for improvement.

While the group's net-zero focus on scope one and two emissions are credible, additional leadership is required to tackle scope three emissions across the supermarket's broader supply chain.

Following the recent demerger of its retail drinks and hotels business, Endeavour Group, Woolworths is also poised to gain additional interest from ESG-sensitive investors given the business model will no longer be involved in gaming and alcohol retailing.

But, for the most part, the outlook remains positive. Revenue is accelerating again with new lockdowns, however, this is countered by COVID-related costs once again increasing - and now likely to be a more permanent cost going forward. But, for the most part, the outlook remains positive.

The Group has also indicated it plans to spend $2 billion this financial year, an increase of 10% last year on capital expenditure. Additional investment has been proposed for improvement in its supply chain, IT and e-commerce capabilities.

Woolworths also has a more focused business, largely as a result of the Endeavour demerger but also the divestment of its fuel retail business to UK-based fuel business, EG Group, in 2019.

As part of its recent earnings announcement, Woolworths declared a $2 billion off-market buyback, following a full year normalised profit increase of 23% to $2 billion (which includes a contribution from the demerged Endeavour business).

This type of buyback is a positive for the company's fundamental ratios; it reduces shares on issue at a 14% discount to the prevailing price and the structure means that zero taxpayers can receive an 18% premium versus selling their shares on market (on an after-tax basis).

Low or zero rate taxpayers will be able to benefit from a 2021 fully franked yield of 3.7% as well as the advantages of the buyback which involve selling shares back to Woolworths at a potential premium of up to 18% compared to the pre-announcement closing price of $40.82. Shares purchased up until September 1 were eligible to be tendered into the buyback and will also qualify for the final dividend.

Weighing up the known and likely risks to the stock in terms of robust fundamentals, including management capabilities, Woolworths is positioned as a hold. It remains a high-quality business which is evidenced through its strong capital position, excellent cashflow generation and dominant position and market share in its industry. This also means that WOW trades at a premium to its key peers at the current price.

The company's most recent result was solid but largely uneventful. Earnings expectations for the stock have been recently down due to higher COVID related costs and a decline in sales momentum as Australia and New Zealand emerge more permanently from lockdowns in late 2021 and early 2022.

There are no major growth opportunities on the radar at present that would justify further multiple expansion at this time, however, the company continues to provide an attractive fully franked dividend yield of approximately 3.7% to shareholders.

The author's related parties have holdings in WOW.

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