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finance director's report - Woolworths Holdings Limited

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<strong>finance</strong> director’s<strong>report</strong>Norman Thomson (above)Director: FinanceRalph Buddle (below left)Head of corporate <strong>finance</strong>Tracey Chambers (below centre)Head of financial managementJustin Crowhurst (below right)Head of central <strong>finance</strong>Group revenue increased 23.1% to R18.6bn,with turnover up 22.3% and all segmentsdelivering market share gains. Sales grew21.1% to R16bn and 38.1% to R1.4bn in<strong>Woolworths</strong> and Country Road respectively.The group’s gross margin was maintainedat 34.4%, whilst other revenue, derivedmainly from our financial services business,increased 35%.Expenses grew 25.1%, driven mainly by costsassociated with the store roll-out programme,the impact of bad debts in financial services,the exchange rate translation impact ofCountry Road and other expenses includingthe investment in store service levels, volumerelated costs and the conversion to aconcession model at Country Road.expenses (Rm)June 2006DepreciationgrowthOccupancycosts growthEmploymentcosts growthBad debts andprovisioning growthCountry Roadexchange rateOther expensesgrowthJune 20074 314.139.592.9381.3135.0118.1315.65 396.5Group profit before tax and exceptional itemsincreased 17.7% to R1 466.8m.Gross interest charged increased by 55.3% toR378.7m. This was largely attributable to anincreased in the prime borrowing rate of 2%over the course of the 2007 financial year, anda 34% year-on-year increase in the averageborrowings of the group driven by the growthin financial services assets.The exceptional item of R54.6m arose fromthe profit on the disposal of a property inMidrand, with a net book value of R27.9m.The group’s lower effective tax rate of 28.6%(2006: 32.8%) was primarily the result of therecognition of a deferred tax asset relating toasset timing differences in Country Road,partly offset by a higher Secondary Tax onCompanies (“STC”) charge as the groupreturned to making distributions fromretained income as opposed to sharepremium. Headline earnings per share wasdiluted by 2.3 cents as a consequence of theshares and share options granted in terms ofthe employee incentive schemes.8woolworths holdings limited annual <strong>report</strong> 2007


key segmental performance statisticsGroup Retail Financial services<strong>Woolworths</strong>Country Road2007 2006 2007 2006 2007 2006 2007 2006Rm Rm Rm Rm Rm Rm Rm RmRevenue 18 641.9 15 114.8 16 099.5 13 288.7 1 361.8 993.6 1 274.4 941.4Sales 17 376.9 14 208.0 16 005.0 13 213.8 1 354.0 980.7 17.9 13.5Gross profit 5 977.0 4 867.6 5 172.3 4 328.0 786.8 526.1 17.9 13.5Gross margin 34.4% 34.3% 32.3% 32.8% 58.1% 53.7% 100.0% 100.0%Expenses 5 396.5 4 314.1 4 001.5 3 333.7 737.9 520.0 750.9 539.3Operating profit 1 845.5 1 490.3 1 265.3 1 069.2 56.7 19.0 523.5 402.1Operating margin 9.9% 9.8% 7.9% 8.0% 4.0% 2.0% 41.1% 42.7%Finance costs 378.7 243.9 12.5 – 1.8 4.1 364.4 239.7Profit before tax 1 521.4 1 246.4 1 307.4 1 069.2 54.9 14.9 159.1 162.4Return on equity 35.1% 34.8% 65.4% 58.6% 34.6% 6.2% 11.9% 14.7%segmental performanceThe performance and required returns of thegroup are managed on a segmental basis inaccordance with each segment’s businessmodel. Key segmental performance statisticsare included in the table above.<strong>Woolworths</strong> – retailThe gross margin in <strong>Woolworths</strong> reduced from32.8% to 32.3% due to one-off transition costsof approximately R45m related to the finalimplementation of our new stock managementsystems. We expect the dilution in grossmargin as a result of the increasingly dominantfood contribution to be offset by highermargins in our clothing business. Both businessmodels generate sustainable value forshareholders in their own right.Expenses grew 20%, driven mainly by costsassociated with the continued store roll-outprogramme and investment in store servicelevels, and volume related store anddistribution costs.Trading densities in clothing and generalmerchandise increased by 11.4% toR23 636/m 2 (2006: R21 225/m 2 ) and in foodby 7.4% to R80 188/m 2 (2006: R74 673/m 2 ).Profit before tax grew 22.3% to R1 307.4m,with return on equity increasing from 58.6%to 65.4%.Country RoadCountry Road’s retail sales were 15.8% higherin Australian dollar terms with strongcomparable store growth of 12.6%.Gross margin in Australian dollar termsincreased from 53.7% to 58.1% as a result ofbetter primary margins, lower mark-downsand the exit of wholesale.Expenses increased by 20.8% in Australiandollar terms as a result of the move to thehigher margin concession model, and 41.9% inrand terms, due to the average exchange ratefor the period moving from R4.78 to R5.67 tothe Australian dollar.Profit before tax grew 268.5% to R54.9m,with return on equity increasing from 6.2%to 34.6%, in rand terms.trading densities –clothing, home and beauty (R/m 2 )trading densities –food (R/m 2 )200723 636.1200780 187.6200621 224.9200674 673.0200520 457.3200568 782.9200419 540.0200462 518.22003 18 230.42003 56 793.5woolworths holdings limited annual <strong>report</strong> 20079


Financial services assets and interest-bearingborrowings carry interest rate risk. The groupmanages this exposure on a net basis,recognising the natural hedge that existsbetween the assets and liabilities. However,during most of the year, this natural hedgewas not effective due to the usury rate freezediscussed above. This was partially offset byinterest rate hedges, which, as at30 June 2007, totalled R1.95bn. As part ofthe process of managing the group’s fixed andfloating rate borrowings mix, the interest ratecharacteristics of new borrowings andrefinancing of existing borrowings arepositioned according to expected movementsin interest rates.It is the group’s policy to cover all foreigncurrency exposures arising from theacquisition of goods and services withforward exchange contracts.1.3m shares were repurchased and cancelledin the second half of the year at a cost ofR26.3m, representing a weighted averagerepurchase price of R20.76 per share. InFebruary 2007 we completed a furthersecuritised bond issuance amounting to R1bnas the first tranche of our initial issuancematured.Our dividend policy remains at a cover of1.7 times headline earnings per share.accounting standardsThe annual financial statements have beenprepared in accordance with InternationalFinancial Reporting Standards (“IFRS”).During the year, loans granted to participantsin the group’s share incentive scheme wererestated to reflect their amortised cost, asrequired by IAS 39 – Financial Instruments:Recognition and Measurement. These loanswere previously disclosed at cost.Various IFRS, IFRIC interpretations andamendments were adopted during thecurrent year. These standards andamendments had no impact on the group’s<strong>report</strong>ed results. Details of these standardscan be found in note 1 on page 61 of theannual financial statements. All additionaldisclosures required by these standards havebeen provided for both the current andcomparative period.prospects and financialtargetsWe expect the retail gross margin to bemaintained during 2008 despite the increasedcontribution of food. We also expect thatinflation will tick upwards both in food, withrising international commodity prices, and inclothing where margin pressure is being felt inChina as local yuan denominated input costsrise against a weakened US dollar. Expectedincreases in fuel prices may further impedeon the strong growth experienced by theretail industry over the last few years.Operating costs will continue to reflect theincreased level of activity and investmentin store service initiatives, whilst bad debts areexpected to remain under pressure.Capital expenditure is expected to beapproximately R800m, of which R650m isplanned for the <strong>Woolworths</strong> storeroll-out and modernisation programme, aswell as for other approved projects. R150m isplanned for the Country Road storeexpansion programme and other capitalprojects.The group’s BEE employee share ownershipscheme was implemented in July 2007 and isexpected to result in an IFRS charge of R68mto the income statement in 2008, and R201mover the subsequent seven years. Dilution inheadline earnings per share resulting fromissuing convertible, redeemable,non-cumulative, participating preferenceshares to the participants of the scheme isexpected to amount to 2.3%.We expect the group effective tax rate to beapproximately 33.5%, a function of the normalrate of income tax of 29% and the STC ratereduction to 10% from 1 October 2007. Inaddition, no tax deduction will be claimed forthe IFRS 2 charge arising from the group’sBEE employee share ownership scheme,adding to the expected increase in theeffective tax rate.We have set ourselves the followingmedium-term financial targets for the53 weeks to 30 June 2008: group returnon equity of 35% and an operating marginof 10%.woolworths holdings limited annual <strong>report</strong> 200711

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