Woolworths' turnaround will take longer and cost more than originally expected, according to analysts, who have downgraded profit forecasts following new chief executive Brad Banducci's strategic review.
Woolworths shares fell 76c, or more than 3 per cent, to $23.54 on Tuesday, giving up some of Monday's 8 per cent gain, as analysts and investors reassessed the retailer's prospects one year into a three-to-five year turnaround.
UBS analyst Ben Gilbert downgraded earnings per share forecasts by between 1 and 3 per cent over the next three years, citing a slower than expected rebound in supermarkets and worse than expected performance at BIG W.
"We continue to believe Woolworths has strong bones and that the issues facing the business can over time be fixed," said Mr Gilbert. "However, in our view the turnaround will take longer and cost more than many expect."
The risk of further earnings downgrades was high because Woolworths needed to continue to invest in price and service to restore same-store sales growth and regain market share.
"While we believe Woolworths is nearing the bottom, the pace of change is slower and is costing more than originally planned," Mr Gilbert said.
'Text book' restructure
Mr Banducci shocked investors on Monday by announcing another $959 million in restructuring costs, taking charges and write-downs this year to $4.2 billion pre-tax and leading to a bottom line loss in 2016 of $1.3 billion.
Mr Banducci, who took the helm from former CEO Grant O'Brien in February, outlined plans to close stores, curtail new store development, sell off assets, starting with the EziBuy business acquired only three years ago, and cut head office staff by another 10 per cent while shifting about 1000 staff into Woolworths' divisions.
Credit Suisse analyst Grant Saligari applauded Mr Banducci's new strategy, describing it as a "text book retail restructuring."
Investment into price and service in supermarkets appeared to be helping to stabilise volumes and the renewed focus on store refurbishments rather than new stores was likely to boost same-store sales in 2018, Mr Saligari said.
However, Credit Suisse expects Australian supermarket earnings to fall another 4 per cent in 2017 after slumping 37 per cent in 2016 due to weaker margins, while earnings growth in other divisions is likely to be subdued. Credit Suisse expects group earnings to rise just 1.2 per cent in 2017 to $2.59 billion.
Macquarie Equities analyst Andrew McLennan also trimmed his profit forecasts for the next few years and said Monday's share price bounce seemed overly optimistic.
"There still remains significant uncertainty around Woolworths' medium term, earnings profile and in our view the stock is factoring in a large degree of optimism, based on the current share price," Mr McLennan said.
Volume growth in supermarkets was likely to remain tentative and was likely to be offset by continued deflation in 2017, he said, keeping pressure on margins.
Deutsche Bank analyst Michael Simotas expects Woolworths' supermarket earnings and group earnings to continue to fall in 2017, despite the heavy cost cutting in 2016.
"We applaud the move to close sub-optimal stores and open fewer new ones, and like for like unit growth in June/July is promising," Mr Simotas said.
"However, deflation intensified in the fourth quarter, which is likely keeping like for like sales negative. The resultant deleverage is compounding at least another nine months of price investment."
"Industry feedback suggests staff morale and out of stocks are still significant issues and Coles' continued aggression could keep the market in deflation for some time yet," he said.
Ratings agency Moody's Investor Services said the restructuring would not impact Woolworths' Baa2 negative credit rating or outlook, despite hefty cash costs of almost $400 million and a 32 per cent fall in earnings from continuing operations in 2016.
"Such cash costs and the lower expected EBIT are credit negative," said Moody's vice president Ian Chitterer, "but the strategy and actions announced are supportive to the company's credit profile and the removal of capitalised leases from the company's balance sheet will have a positive impact on Moody's adjusted debt/EBITDA metric."
"Consequently, we do not view the update to impact Woolworths' rating or outlook."
- This story first appeared on The Financial Review.