Running head: Woolworths Financial Analysis

Woolworths Group Ltd Analysis

Name
Institution
Woolworths Group Ltd. 2

1 Risk and return

1.1 Estimating historical risk parameters
An analysis of the last five years stock price of Woolworths compared to that of the ASX index
was used in the analysis of the risk and return of the Woolworth’s stock. the results are presented
below.

Regression Statistics
0.47959
Multiple R 8
0.23001
R Square 4
Adjusted R 0.21650
Square 5
Standard 0.03732
Error 9
Observations 59

ANOVA
Significan
  df SS MS F ce F
Regressi 0.0237 0.0237 17.027
on 1 27 27 32 0.000121
0.0794 0.0013
Residual 57 27 93
0.1031
Total 58 54      

Coefficient Standard Lower Upper

  s Error t Stat P-value 95% 95%
0.39224 0.69634
Intercept 0.00196 0.004998 4 1 -0.00805 0.011969
X Variable 4.12641 0.00012
1 0.631561 0.153053 7 1 0.325077 0.938044

From the results the equation of the relationship is

Woolworths = 0.6316ASX + 0.00196
The beta value of 0.6316 is an indication that the ASX index is more volatile compared to the
Woolworth stock. This shows price stability and a good investment option.
Woolworths Group Ltd. 3

Cost of Equity:

In determining the cost of equity, the Capital Asset Pricing Model (CAPM) will be utilized to
determine the required rate of return. The formula is:

Cost of Equity = Risk-Free Rate of Return + Beta of Asset * (Expected Return of the Market -
Risk-Free Rate of Return).

Cost of Equity (ke) = Rf + β (E(Rm) – Rf)

Where:
Rf = the 10-Year Treasury Constant Maturity Rate that is updated daily and is
currently quoted at 0.95000000%.
β= the sensitivity of the expected excess asset returns to the expected excess
market returns. Woolworths Group's beta is 0.22.
(E(Rm) – Rf) the market premium (Expected Return of the Market - Risk-Free Rate of
= Return). In the calculations, this value is assumed to reflect the one provided
by GuruFocus of 6%.

Cost of Equity = 0.95000000% + 0.22 * 6% = 2.27%

1.2 Estimating default risk and cost of debt

Cost of Debt

In these calculations the last fiscal year end interest expense is used and then divided by the
latest two-year average debt to determine a simplified cost of debt. As of Jun. 2019, Woolworths
Group's interest expense (positive number) was $87.5 Mil. Its total Book Value of Debt (D) is
$2137.05803348 Mil.[ CITATION Gur191 \l 1033 ]

Cost of Debt = 87.5 / 2137.05803348 = 4.0944%.

Estimating cost of capital

WACC = E / (E + D) x Cost of Equity + D / (E + D) x Cost of Debt x (1 – Tax Rate)

Weights

In financing a company, a choice is made of either debt or equity. And in order to calculate the
cost of capital an analyst needs to determine the weight of equity and that of debt.
The market value of equity (E) is sometimes referred to as the Market Cap. The provided market
capitalization (E) of Woolworths Group Ltd. is $31571.277 Mil. [ CITATION Gur191 \l 1033 ]
Woolworths Group Ltd. 4

Given the difficulties in calculating the market value of debt an analyst would assume that it is
equal to the book value of debt (D). this is further simplified by adding the latest two-year
average short-term debt & capital lease obligation and long-term debt & capital lease obligation
together. The provided 2019 values for the latest two-year average short-term debt & capital
lease obligation was $ 321.525695486 mil and its latest two-year average long-term debt &
capital lease obligation was $ 1815.532338 Mil. The total Book Value of Debt (D) is therefore an
addition of both these values to give $ 2137.05803348 Mil. [ CITATION Gur191 \l 1033 ]

a) weight of equity = E / (E + D) = 31571.277 / (31571.277 + 2137.05803348) = 0.9366

b) weight of debt = D / (E + D) = 2137.05803348 / (31571.277} + 2137.05803348) = 0.0634

In order to satisfy the final section of the WACC computation (one minus Average Tax Rate) the
latest two-year average tax rate (29.995%) is used to do the calculation.

Having determined the cost of equity as 2.27% and the cost of debt as 4.0944% we substitute in
the WACC equation. Woolworths Group Ltd.’s Weighted Average Cost of Capital (WACC) is
calculated as:

WAC
=E / (E + D)*Cost of Equity+D / (E + D)*Cost of Debt*(1 - Tax Rate)
C

=0.9366 *2.27% +0.0634 *4.0944% *(1 - 29.995%)

=2.31%

Return on Invested Capital (as at June, 2019)

= NOPAT/ Average Invested Capital
= Operating Income x (1-Tax Rate) ÷ ((Invested Capital (as at Jun. 2018) + Invested Capital (as
at Jun. 2019)) / 2)
= 1434.02777778 x (1 - 30%) ÷ ((9279.6101949 + 8841.66666667) / 2
= 1003.81944444 / 9060.63843078
= 11.08%

There is a cost associated with raising capital. Therefore, a generation of higher ROIC compared
to the WACC shows an earning in excess of returns. A firm with the vision to generate sustained
positive excess return on new investment undertakings in the future is likely to have to
experience an increase in value with a corresponding growth increase. On the other hand, if a
firm generates returns that are not at least equivalent to its cost of capital is likely to experience a
drop in value as it grows.
Woolworths Group Ltd. 5

From the results calculated above, Woolworths Group's weighted average cost of capital is
2.31%. The firm’s ROIC is calculated as 11.08%. Woolworths Group generates higher returns on
investment than it costs the company to raise the capital needed for investments during the 2019
fiscal year. This shows that the firm is earning excess returns, indicative that the firm expects to
sustain generation of positive excess returns on new investments in the future and is likely to see
its value increase as its growth increases [ CITATION Gur193 \l 1033 ].
Woolworths Group Ltd. 6

2 Earnings and cash flows

2.1 Analyzing existing investments
The enterprise value of the firm to it EBITDA is used as a good ratio to determine the value of
the company in both finance and investment. In conjunction with the PE ratio the ratio is used to
calculate the fair market value of the company.
Woolworths Group Ltd.’s stock price is $ 24.7 and its diluted earnings per share for the trailing
twelve months ending June 2019 was reported as $ 1.42. These values give Woolworth’s PE
ratio at 17.55. however, the PE ratio unlike the EV to EBTIDA ratio, fails to capture the firm’s
debt and net cash.
EV-to-EBITDA = Enterprise Value (as at October 2019) ÷ EBITDA (TTM
= 33222.527 ÷ 1634.02777778
= 20.33
The results show that the firm’s current earnings are better than their pre-tax earnings for the
trailing twelve months ending June 2019. The firm’s EV to EBITDA is in line with both the cost
of equity and cost of capital. All these ratios show a firm that is able to earn in line with its
investments. The firm is capable of maintaining growth even in times of business slowdown or
recession.
Enterprise Value (as at Jun. 2019)
= Market Cap + preferred Stock + Long-Term Debt & Capital Lease Obligation + Short-Term
Debt & Capital Lease Obligation + Minority Interest - Cash, Cash Equivalents, Marketable
Securities
= 30715.191 + 0 + 1982.63888889 + 190.277777778 + 265.972222222 – 740.277777778
=32,414
The firm’s enterprise value for 2019 (32,414) shows an increase from the previous year’s value
of $ 30,669.74 Mil. The value for 2018 fiscal year is also higher that that reported in 2017
(27,001.29). this sows a growth of the value of the firm form year to year.
2.2 SWOT analysis
2.2.1 Strengths
Strengths are the key advantages the firm has over its competitors in the industry. Woolworths
Group Ltd. Strengths are as follows:
Market leadership: there are only two key players in the Australian retail market. Both Coles
and Woolworths control most of the market share. In this context, Woolworths owns more than
50 percent of the market therefore reducing the threat from other players in the market.
Segment penetration: Woolworths’ strategy was to target the wealthy class and to do so they
made sure all upscale brands were full stocked in their outlets. From here the firm moved into the
Woolworths Group Ltd. 7

lower value segments and made sure their private labels were value brands. This has given them
a strong presence in both ends of the market.
Perception: the key to Woolworths success is the public perception and striking a balance across
different economic levels. This has been achieved by utilizing a pricing and promotion policy
that is neither low end nor premium. This strategy has helped increase their market hold in the
middle-income economic segment.
Employee policies: the firm draws its positives from employing a diverse workforce. This is
coupled with proper training. In addition, the firm offers bonuses to its employees on a regular
basis.
Good customer tracking: using business analytic tools specifically developed and social media
analytics the firm keeps track of its customer pool. They also keep track of the purchasing habits
of its customer so that goods consumed by its customers are always in stock.
Promotions: the firm carries a rigorous promotion strategy in which customers are informed on
a weekly basis. The firm also uses value proposition and tries to keep the entry level prices as
low as possible.
2.2.2 Weaknesses
These ae the areas that the firm needs to make improvements to capture more of the market
Mixed positioning: the target of multiple income segments using similar products results in the
consumers being confused on whether the supermarket really offers any value price.
Partiality: although the firm cuts across all market segments it has been known to be partial to
the high-income segment because of the higher returns. They thus get more attention and better
products plus services.
Price wars: there a close competition between Woolworths and Cole. This has resulted in the
firm making some pricing mistakes that have caused it losses.
2.2.3 Opportunities
The experience: it is a lackluster show form most retailers with all of them offering the same
thing especially to the value segment. An opportunity for Woolworths would lie in creating a
different in-store experience. Experiences such as self-checkouts and personalized services
would help differentiate the chain store and bring in extra income.
2.2.4 Threats
Competition: the currently biggest competitor to Woolworths is Cole but the entry of Amazon
into the food retail business might soon see the competition rise.
Focus on health: the self-awareness of today’s customers means that firms have to rethink their
product portfolios to accommodate these new trends. The advent of organic and chemical free
foods has made this change very real.
Woolworths Group Ltd. 8

3 Source of finance
3.1 Assessing current financing
The company has implemented several strategies of financing. The firm operates on a strict
capital structure and a borrowing policy in a view to reduce liability to shareholders. The capital
structure is managed with an objective of improving the shareholder value in the long term by
financing its operations using an optimized weighted cost of capital.
Mid 2019 (May), the firm returned capital to shareholders through a buy back strategy at an off
the market purchase at a cumulative cost of $ 1.7 billion.
3.2 Cost of debt

The general financial strength of Woolworths is measured using two ratios, its interest coverage
ratio and the firm’s debt to revenue ratio. A strong posting in these ratios is an indication that the
firm is less likely to go bankrupt in case of business slowdowns or recession.

Interest coverage ratio is a measure of the ease of a firm to pay out its interest expenses on its
debt obligations. This is calculated by dividing the firm’s operating income (EBIT) by its interest
expense.
Interest Coverage = - 1 x operating income (quarter ending June 2019) ÷ Interest expense
(quarter ending June 2019)
= - 1 x 511.805555556 ÷ -38.1944444444
= 13.40
The ratio shows that from the firm’s operating income it is able to pay out its debt obligations
thirteen times over.
The debt to revenue ratio on the other hand looks at whether the firm is able to meet both its long
term and short-term obligations based on their revenue.
Debt to
=Total Debt (Q: Jun. 2019) / Revenue (Q: Jun. 2019)
Revenue Ratio
(Short-Term Debt & Capital Long-Term Debt & Capital /
= + Revenue
Lease Obligation Lease Obligation)
/
=(190.277777778 +1982.63888889) 20414.5833333

=0.11
Woolworths Group Ltd. 9
Woolworths Group Ltd. 10

4 Dividend policy
4.1 Historic dividend policy analysis
Woolworths Group Ltd. Pays out dividend on a year to year basis. The dividend amount is
determined in June of every year. The Board of directors typically declare the final dividend
amount in August of the same year but the dividends are actually paid out in September or
October. In addition, the dividend paid out is fully franked at a 30% tax rate.
The firm also has a dividend reinvestment plan (DRP). The DRP policy involve a participation-
based structure. Eligible shareholders are encouraged to participate with either all their
shareholding capacity or just part of it. A discount rate may be applied to the DRP in line with
the board’s long-term objectives. The previous fiscal year (2018) shareholders got a discount for
reinvesting their dividends but the same was not applied to the most recent fiscal year’s dividend
reinvestment plans. The firm however, maintains a no limit policy on the number of shares any
shareholder may use in their DRP.
Under the DRP policy, all participants are allocated shares at an amount that is the same as the
mean of the average of the daily volume weighted average market price of its ordinary shares
traded on ASX over a period of 10 trading days, two months after the close of the fiscal year.
Before payment of the DRP, the firm may acquire shares on-market in order to satisfy the
obligations set out in the DRP.
In the latest fiscal year, the rate of dividend reinvestment dropped from the previous fiscal year’s
(2018) of 39.9% to less than half of the initial volume to 13.4%. This drastic drop in volumes
reinvested reflects the removal of the discounting plan that worked so well in 2018. For the
current fiscal year, dividends were satisfied in full by use of the on-market purchases and transfer
of shares to participating shareholders.
The firm paid out a total amount of $ 1,381 Mil in 2019. Of this, $ 593 Mil represented the
year’s interim dividend, $ 657 Mil represented previous year’s final dividend and $ 131 Mil
represented the previous year’s special. This is slightly lower than what was paid out in 2018. In
2018, the firm paid out 1,208 Mil. Of this, $ 561 Mil represented the year’s interim dividend, 647
Mil represented previous year’s final dividend and there were no specials in the year preceding
2018.
4.2 Firm characteristics
Woolworths Group Ltd. Has a total number of 356,152 shareholders. Of these, the largest
number have between one and one thousand shares per individual shareholder. The portion of
shareholders owning 100,000 and more shares consists of 104 shareholders [ CITATION Woo19 \l
1033 ].

Dividend Payout Ratio = Dividends per Share (as at Jun. 2019) / EPS without NRI (as at Jun.
2019)
= 0.347222222222 / 0.788865277778
= 0.44
Woolworths Group Ltd. 11

This dividend pay out ratio represents the percentage of the firm’s earnings that is paid out as
dividend. In Woolworths case 44 percent of its earnings is paid out to its shareholders as
dividends. This is quite a high pay out ratio. However, compared to its competitors in the market
the pay out ratio might be considered an average percentage. For instance, Koninklijke Ahold
Delhaize NV (0.45), CP All PCL (0.53), Loblaw Companies Ltd. (0.65) and Whole Foods
Market Inc (0.49) all pay a higher percentage than Woolworths group Ltd. This is significant
given that Woolworths has a higher market cap compared to the aforementioned
competitors[ CITATION Gur19 \l 1033 ].

5 Corporate valuation
This valuation method is utilized in determining the fair value of a dividend stock. it assumes
that the fair value of a n asset is equal to the total future cash flows discounted back to fair value
using an appropriate discount rate.
The growth rates and future dividends are calculated under several assumptions. The earnings are
assumed to grow at an estimated 9 percent. The EPS for the past five years was obtained form
financial market site, Guru Focus, as $ 1.31. in the calculation of the fundamental growth, the
current EPS was calculated from the provided figures of the Fiscal year 2019 at $ 0.79, the
current dividend per share is $ 0.35 and the book value of equity is $ 24.70.
From these return on equity is calculated as 3.20% and the retention ratio is also determined as
56.08%. the weighted average growth rate is then calculated as 1.25% with a discount rate of
7.55%. the price at the end of high growth stage was determined as $76.85 with a dividend value
at the same stage of $ 1.45. the present value of the terminal face is $ 53.40 with a n intrinsic
value of $ 54.86.
If we compare the current market price of the company at $ 34.70 and the computed price at end
of growth stage of $ 76.85 which tells us that the stock is clearly undervalued.

6 Real options
6.1 Black-Scholes Model
C= paN ( da )− peN (d 2) e−rt
Present value of cash flow (Pa) = $ 2,800 Million
Cost of initial Investment (Pe)= $ 2,900 Million
NPV of project = $ 2,900 - $ 2,800 million = $ 100 million
Exercise date (t) = 13 years
Risk free rate (r) = 5%
Volatility (s) = 40%
Woolworths Group Ltd. 12

d 1=
ln ( PaPe )+(r +0.5 s ) t
2

s√ t
D1 = (- 0.03509 + 0.26) / 0.565685
D1 = 0.397586
d 2=d 1−s √ t
= 0.397586 – 0.565685
= - 0.1681

C= paN ( d 1 )− peN (d 2)e−rt

C = 3212.9236 – (446.22835)
C = $ 2766.6952 Mil

P=C− pa+ pe × e−rt

P = 2766.6952 – 2800 + 1513.93
P = $ 1480.63
The net present value with the put option is $ 1480.63 – $ 100 = $ 1380.63 Mil
Although other sensitivity analysis should be done, based on the results above alone the project
is a good venture to undertake given its positive net present value.
Woolworths Group Ltd. 13

References
Guru Focus. (2019, October 13). Woolworths Group EPS without NRI. Retrieved from Guru

Focus: https://www.gurufocus.com/term/eps_nri/WOLWF/EPS-without-

NRI/Woolworths%20Group

Guru Focus. (2019, October 13). Woolworths Group EV-to-EBITDA. Retrieved from Guru

Focus: https://www.gurufocus.com/term/ev2ebitda/WOLWF/EV-to-

EBITDA/Woolworths%20Group

Guru Focus. (2019, October 13). Woolworths Group ROIC %. Retrieved from Guru Focus:

https://www.gurufocus.com/term/ROIC/WOLWF/ROIC-Percentage/Woolworths

%20Group

Guru Focus. (2019, October 13). Woolworths Group WACC %. Retrieved from Guru Focus:

https://www.gurufocus.com/term/wacc/WOLWF/WACC-Percentage/Woolworths

%20Group

Woolworths Group Ltd. (2019). Better Together 2019 Annual Report. Woolworths Group Ltd.