Woolworths flags $220m first-half Covid hit; not returning to ring-fencing profit margins

Woolworths has downgraded profit and earnings expectations over rising costs related to Covid-safe stores and disrupted supply chains.

Woolworths is counting the costs of the pandemic, but staff will get a bonus. Picture: Adam Head

Woolworths shareholders will wear the bruises of more than $220m in bloated costs linked to Covid-19, from hiring nurses to administer rapid antigen tests at worksites to wiping down stores, as the nation’s largest retailer chooses to sacrifice profits rather than sales.

Chief executive Brad Banducci quickly rebuffed any suggestion that Woolworths would seek to recoup some of its pandemic costs now infecting some parts of his supermarkets and Big W businesses by hiking up prices, arguing Australians expected competitive pricing in the lead up to Christmas.

The cost of that decision became clear on Tuesday when Mr Banducci unveiled a profit warning to the market that will see his flagship Australian supermarkets – the workhorse of the Woolworths group – suffer as much as an 8 per cent slide in earnings which triggered a 10 per cent slump in the share price.

It also dragged down rival supermarket operator Coles, whose shares slid more than 6 per cent on the Woolworths costs revelations, as the crippling costs now saddling corporate Australia from the pandemic starts to become a problem for investors.

Woolworths advice.

Shares in Woolworths retreated 10.5 per cent to a low of $36.26 wiping off almost $5bn from the company’s market capitalisation when Woolworths issued a trading update on Tuesday that included the news it was expected to swallow total direct and indirect costs linked to Covid-19 of as much as $220m in the first six months of fiscal 2022.

For the first half, Woolworths said direct Covid-19 costs in its Australian food arm are expected to be around $150m, or 0.6 per cent of sales, with the costs split between supply chain (including customer fulfilment centres), and stores, to ensure the safety of customers and team. In addition, the indirect disruption to stores and distribution centres has led to elevated operating costs of approximately $60m to $70m in the half.

But with one eye on arch rival Coles, as well as the rest of the $100bn-plus grocery sector looking to peel away shoppers from Woolworths, there was no stomach to ratchet up prices outside of current food inflation to grab back some of those Covid costs.

“We are seeing some inflation creep into the market, and where we are adjusting prices is where the cost of the product itself has gone up not where our underlying operating costs have gone up,” Mr Banducci said.

“What we always aspire to do is to become more efficient, provide more value back to our customers so the price increases you see, and there have been some and we will expect that to continue into the new year, is really more driven by the underlying cost of the product.

“We are very careful to make sure we deliver value for our customers in particular at Christmas time, the last thing you want to be in is that scenario where we are not delivering safe, affordable and inspirational Christmas for our customers.”

This meant earnings would take a hit. Woolworths said on Tuesday earnings before interest and tax for its Australian supermarkets business will be $1.19bn to $1.22bn, which will undershoot analyst forecasts. This compares to a first half EBIT of $1.33bn last year. It represents a fall between 7 per cent and 8 per cent, compared to the prior corresponding period, or by around $100m.

Shares in Woolworths later closed down $3.11, or 7.67 per cent, at $37.45 while Coles closed down 49 cents, or 2.74 per cent, to $17.38.

Mr Banducci said he wanted Woolworths to remain competitive heading in to Christmas and providing great value for customers and that prices would not be lifted to counter the higher costs, many of them one-off, as it deals with Covid-19.

But he said Woolworths wouldn’t compromise on stock levels as it prepared for Christmas and would not return to the old days of Woolworths in 2015 and 2016 when the supermarket retailer held tight to its profit margins but sacrificed market share.

“We don’t want to repeat the mistakes of the past,” he said.

The difference between those days and now is the strains on the business from the global pandemic. Supply chain costs were also impacted by higher volumes, fuel price increases and the impact of balancing supply across distribution centres on the eastern seaboard, Mr Banducci said.

Woolworths had acted to rein in costs, this includes the deferral of a number of planned performance improvement initiatives that have been delayed to allow teams to focus on serving customers in the lead up to Christmas.

But its sales growth was starting to moderate, worsening its trading position. Following the easing of lockdowns in New South Wales and Victoria through October, sales in its supermarkets moderated as customers returned to more normal patterns of shopping and filling their pantries. Sales have also been dented by inclement weather, primarily in NSW, which has cut the opportunity for outdoor dining and entertainment. Woolworths said total sales in the second quarter to date were up 2 per cent compared to the same period in the prior year and much stronger sales growth of 3.9 per cent for the first quarter of 2022.

“The first half of 2022 has been one of the most challenging halves we have experienced in recent memory due to the far-reaching impacts of the Covid Delta strain and its impact on our end-to-end stock flow and operating rhythm,” Mr Banducci said.

“We have continued to put the health, safety and wellbeing of our customers and team first in the context of this challenging and volatile operating environment.”

Mr Banducci said as Woolworths heads into the key Christmas trading period it has a good in-stock position and positive trading momentum, and the team is working hard to ensure customers have access to all they need to make this a special Christmas.

To recognise the significant efforts of all the group’s front line teams across Australia and New Zealand, the results will also include a special group team Christmas Thank You bonus payment of $35m to $40m as previously disclosed.

“Despite the various disruptions, we have made good progress activating our strategy and have continued to selectively invest in building out our customer proposition and broader retail ecosystem,” Mr Banducci said.

“As customer behaviours begin to normalise and Covid-related supply volatility reduces, we expect an improvement in our underlying operating performance and we will provide a more detailed update on the outlook for the remainder of 2022 at our first half results in late February.”

Mr Banducci said the “silver lining” in this was that Woolworths was focused on the right priorities for the second half and crucial sales periods in January such as return to school.