Some self evident truths in Woolworths Group and Richemont
BHP’s bid for Anglo American pointed out some truths which, while self-evident, investors ignored for a long time, and were willing to continue with the status quo well into the future. The truth BHP pointed out is that the different businesses in Anglo American attracted materially different risk premia. Not only does the copper business in Anglo American have a lower risk premium than the diamond, PGM, coal, and fertilizer businesses; mines located outside South Africa were more attractive than mines located in the country.
- You can apply an analogous thought process to several JSE listed companies, including Woolworths and Richemont:
That Woolworth’s food business perennially and structurally outperforms the clothing business is as self-evident a truth as man being created equal.
That, on the same basis, the Richemont jewellery business outdoes the luxury watch businesses is as self-evident a truth as man’s pursuit of liberty.
Management teams of both have not purposely neglected their underperforming units, on the contrary they have invested significant resources in those divisions. However, the weight of evidence patently makes the case that Woolworths is far better at retailing food and Richemont’s skills are superior at retailing jewelry.
Chart 1 shows the evolution of both food and clothing Woolworths revenue contributions since 2009. The ratio has gone from parity to overwhelming domination by food. Importantly, all food revenues are organic, derived in South Africa while clothing jumped after the acquisition of David Jones in Australia (2015 – 2021). Even with this boost clothing has simply been inglorious.
Chart 1: Contribution to Sales: Woolworths Group Food vs. Clothing Retail (2009-2023)
Source: Capital IQ, First Avenue-Northstar
Removing the impact of Australia shows just how much food retail has completely overwhelmed clothing retail in the same period.
Chart 2: Contribution to Sales: Woolworths S.A. Food vs. Clothing Retail (2009-2023)
Source: Capital IQ, First Avenue-Northstar
Turning to Richemont, while the watch division has always contributed less than the jewellery division (23% vs 54% in 2004), the division’s contribution to sales is now down to 18% (2023) while jewellery is up to 69%. The watch division is slowly being drowned out by jewellery. Again, this is despite Richemont acquiring a few watch brands along the way.
Chart 3: Contribution to Sales: Richemont Jewellery vs. Watches (2000-2023)
Source: Capital IQ, First Avenue-Northstar
Profitability
The trend of value diminution in clothing retail and luxury watches in Woolworths and Richemont respectively is also evident in operating margins.
At a group level (S.A. and Australia), the operating margin for the food division has steadily increased –through organic growth we should mention) while clothing peaked in 2015 (due to the acquisition of David Jones in Australia) and then declined markedly since.
Chart 4: Operating Margins: Woolworths Food vs. Clothing Retail (2000-2023)
Source: Capital IQ, First Avenue-Northstar
Excluding the impact of Australia (which boosted clothing), profitability in food has as surely as the sun rises in the East and sets in the West, trounced profit contribution by the clothing business.
Chart 5: Operating Profit Margin S.A. Only: Woolworths Food vs Clothing (2009-2023)
Source: Capital IQ, First Avenue-Northstar
Turning to Richemont, the jewellery division has increasingly driven the company’s profitability while the profitability of the watch division has languished in mediocrity.
Chart 6: Operating Profit Margins: Richemont Watches vs. Jewellery (2000 – 2023)
Source: Capital IQ, First Avenue-Northstar
It really is hard to believe that both of Richemont’s divisions once generated the same return on capital invested. Today, the return on capital invested in watches pales in comparison to that of jewellery.
Chart 7: Richemont Divisional Return on Assets (2008-2024)
Source: Capital IQ, First Avenue-Northstar
The market appeal of jewellery relative to watches is further evidenced by the asset turnover (how many times assets in the division produce sales in a year). Richemont’s jewellery is the marvel of the group, turning over 2.8x compared to 1.8x in watches. What’s more, the asset turnover rate in jewellery improved markedly from 1.6x in 2008 to 2.8x in 2024 while that of the watch business has barely budged since 2008 (1.5x – 1.8x).
Chart 8: Richemont Divisional Total Asset Turnover (2008 – 2023)
Source: Capital IQ, First Avenue-Northstar
Industry Peer Review and Valuation Optics
First, from an operating margin standpoint, Woolworths Food stands head and shoulders above Shoprite’s, Spar’s, and Pick n Pay’s. However, in clothing retail, Woolworths comes third after Truworths and Mr. Price (The Foschini Group brings up the rear).
Chart 9: Peer Review: Woolworths Food and Clothing vs Peers
Source: Capital IQ, First Avenue-Northstar
The drag on valuation of the clothing retail division of Woolworths, as perceived by investors, is evident when comparing the valuations of the company to the best-in-class businesses in food and clothing retail sectors. In the consumer discretionary sector in South Africa, the food division gives Shoprite, the market leader in food retail in the country, a run for its money. Yet Woolworths’ price to earnings multiple often trades at a material discount (+20%) to Shoprite’s PE multiple. It makes one wonder if investors, and indeed management, have never wanted to capture that value uplift.
Chart 10: Woolworth’s Structural Discount to Shoprite’s PE Multiple
Source: Capital IQ, First Avenue-Northstar
For Richemont, there is a lot more of margin uplift to capture (30x multiple difference). The company has best in class jewellery. This is comparable to Hermes’ best-in-class soft luxury (leather bags and scarves). Yet the difference in price earnings multiples is as wide as the Grand Canyon.
Chart 11: Richemont vs. LVMH vs. Hermes: Trailing 12m PE Multiples
Source: Capital IQ, First Avenue-Northstar
While the gap between LVMH and Richemont has closed, it is not that comforting a data point because LVMH is an even bigger conglomerate in the luxury segment with interests ranging from soft luxury, hard luxury, wine and spirits, high and mid-end luxury. The lesson here is that a luxury company has a better chance of attracting a very high multiple when it is best in class at a niche and specialist (Hermes) offering and not when it is diversified (LVMH). The reason Swatch does not attract a high multiple is that it is not best-in-class in luxury watches. Philipe Patek is.
Conclusion
Investors have allowed the management teams of Woolworths and Richemont to continually invest scarce resources (time and effort) into business lines that not only produce sub-optimal returns, but also cause significant value leakage relative to best-in-class peers. BHP’s recent efforts have catalyzed management of Anglo American to divest out of inferior assets. What will it take for Woolworths and Richemont management to do the same? Will Woolworths dispose of its clothing retail business when it contributes 5% of sales? What will the opportunity cost of that be if it is 15yrs down the line? The same for Richemont. What contribution to revenues makes the watch business irrelevant to the group?