Okay. Good morning, everyone, and thank you for attending the session today. The purpose of the presentation is to take you through how we have gone about the adoption and implementation of IFRS 16 for the WHL Group and the implications of this for our financial reporting.
As I'm sure you're well aware, IFRS 16 will change the way in which we account for leases, which will have a significant impact in the way in which we present our balance sheet and income statement and will require a recalibration of some key metrics, which I will also cover later on in this presentation. So it's important to bear in mind that while the underlying fundamentals of our business have not changed as a result of the new accounting standard, and it should not, it has highlighted the need to relook at our lease arrangements and better understand our future commitments.
So in preparing for the implementation of IFRS 16, we have, over the last while, embarked on an extensive exercise to review all our lease agreements. And I'm happy to present to you the outcome of this exercise. This presentation is available on the WHL website. And of course, the webcast will be available for download a bit later.
So if I can move on to the agenda, there are 5 sections to the presentation. So firstly, the introduction will cover some of the IFRS 16 principles and theory. I think you should be fairly familiar with a lot of this, so I won't spend too much time on that. We will then cover our transition approach and key principles. We have adopted the modified retrospective approach. And then we will cover some detail with regard to our lease portfolio and discount rates, key inputs into the numbers and probably of most interest to you.
We will then cover the impact on the financial statements and key metrics. And this is in respect of the 2019 financial year, so the opening day 1 adjustment to the balance sheet, the impact on the 2019 financial, the income statement and then some key metrics. And then in closing, we'll just discuss some next steps from here and -- before we conclude and head into questions.
So just moving on to key messages. So to start off with a bit of the technical accounting and broader business implications of the new standard. As you know, for us, it will be effective from the beginning of 2020. The June 2019 results were reported on IAS 17. And the first published results on IFRS 16 will be our interim results presented on the 20th of February next year. So it will have a significant impact on our balance sheet. It will raise our right-of-use assets and the lease liability. And in the case of retailers, which leases most of its stores, this will result in a significant change to the balance sheet and will change assets and liabilities quite substantially.
In terms of the income statement, there's this change in the structure and categorization of costs, especially operating and finance costs. Operating costs will reduce. We take out the rental costs, which is replaced with depreciation. And that increases operating profit. However, we bring in finance costs effectively below the EBIT line. In our case, profit before tax and EPS decreases initially as lease portfolio is on average in the earlier part of the lease term and that's -- and I'll go into a bit of detail as to why that is the case.
So in terms of IFRS 16, and you would have heard this from other retailers and other businesses, it does not change our financial fundamentals, operations or cash flow. However, there is increased focus on reducing tenure and making sure that we build in necessary flexibility and variability within our lease agreements. We've made no secret of the fact that we are overspaced in David Jones, for example. And we have communicated our strategic intent to reduce space across the group, especially within David Jones and especially in light of the growth in online. And I will get into a bit of detail with regard to what our commitments are in each of the businesses. But to also just confirm that leasing remains a key part of our business model, especially as it relates to retail stores.
So moving on to the -- some of the theory. And you would have seen this before, no doubt, so I won't dwell on the next 2 slides for too long. But firstly, on the balance sheet, typical asset and liability profile with -- under the new standard. We start in the same place and we end in the same place. But effectively, it takes a bit of a different route over the period of the lease. And if you adopt IFRS 16 within a lease period, the lease liability tends to be higher than the right-of-use asset because of the front-loading essentially of interest. And as you pay down the capital amount, the implied interest then is lower. So essentially, it's profit-decretive at the start of a lease or the earlier part of the lease and then it becomes profit-accretive towards the end.
Moving on to the income statement. And again, you will have seen these graphs or these graphics before. Over the lease term, the total charge to the income statement under IAS 17 and IFRS 16 is exactly the same with the straight line operating lease effectively replaced with depreciation and the finance charge over the period. And as I mentioned before, the impact on profit before tax when you adopt the statement really depends on the elapsed period of the lease term. And it is dilutive in the beginning and accretive at the end.
Right. So just moving on to our transition approach and key principles. So in terms of our transition approach, we've adopted the modified retrospective approach, like a few of our local and international peers, have done. And under this approach, comparative amounts are not restated. Opening retained earnings is adjusted on day 1 of the financial year of adoption, which for us will be FY 2020. And then pro forma results for FY '20 on an IAS 17 basis will be presented to enable comparability. And we will do that in February at our half year results as well as August at our year-end results. And then we've opted to use certain practical expedients under the modified retrospective approach, which is allowable under the standard and makes implementation a bit easier and less complicated.
So in terms of adjustments to right-of-use assets and lease, effectively, those onerous lease provisions are derecognized and fair value lease adjustments also adjusted against the ROU asset. And the straight-lining lease liability on adoption is offset against equity at the start of the financial year. So nothing out of the ordinary here and nothing that should be of a surprise to you.
So in terms of the key principles in implementing the adoption of IFRS 16, clearly, the term of the lease is -- well, firstly, the lease population is key. You have to make sure that this is complete. We have done an extensive exercise evaluating each store and also non-store lease agreements, such as DCs, warehouse facilities and also looked at supply chain contracts. And we've made sure that, that population firstly is complete. There's over 1,000 leases across the group that we've looked at.
And then second, the second big significant input into the calculation is the lease term and what you assume with regard to that. So under the standard, it is based on, firstly, the noncancelable portion of the lease. And then with regard to exercise of options, you extend this to include options where you are reasonably certain to extend. So that's effectively what we've done. And as I mentioned, we went through every single lease across the group. Turnover-based portion of rentals are excluded from lease commitments as they're contingent on sales levels. And then the right-of-use assets will be subject to annual impairment testing, like any other asset.
Okay. Lease portfolio and discount rates. I think this is an important slide and effectively sets out the number of leases in total and by business. We have the average remaining lease terms, that's both including and excluding options, and then also on a weighted average basis. So I think there's quite a bit of detail in there for you. I think if you look at the second line, average remaining lease term with no options and if you look at Woolworths South Africa and Country Road, quite a high degree of flexibility there with under 4 years and under 3 years, respectively, excluding options. And a total of 6.5 for the group, being pushed up by the longer terms relating to David Jones. And of course, in the case of Country Road, that flexibility is useful when online is at circa 20% of the business and growing. And you have to consider that in terms of your bricks and mortar commitments.
And then if you look at the weighted average remaining lease term, for example, in Country Road, it's substantially higher than the simple average. But that's due to the longer terms for flagship stores. And it also includes our lease relating to our head office. So excluding our head office, the weighted average remaining lease term is 6.4 years versus the 8.1 that you see above there. And then we've given you the lease multiple. Again, in WSA, it's 6x; in Country Road, it's 4.8x; and in DJ, is -- it's substantially higher at about 11x.
On the next page, discount rates. This is an important input into calculating the total lease liability and the ROU assets. For Woolworths, it's 9.5%; David Jones, 4.5%; and Country Road, 4.3%. The standard suggests that you use the interest rate that's implicit in leases. However, we do not have that in our case. And therefore, it's based on the incremental borrowing rate. And we've taken that into account based on the lease term base rates and, of course, the specific debt profile of each of our businesses. And in the case of our Australian businesses, we are going through a refinancing process at the moment. And those rates are aligned to the expected refinancing outcome. David Jones' incremental borrowing rate is a bit higher than Country Road. And that is due to the longer lease terms of DJ compared to Country Road.
Okay. Then if we look at our group lease portfolio, it's a graphical representation of our lease maturity profile over 5-year intervals. The dark blue bars are Woolworths, the green bars are David Jones and the light blue is Country Road. And as you can see that the dark green bars do push us to longer-dated maturities. And as a group, we're on average 35% into our lease term on a weighted average basis. The liability in '45 to '50 consists of a single-tier David Jones store. But we've recently extended that lease, but we do have an option to -- we do have a break clause option within the lease, which we've not taken into account in calculating the liability. And in the -- just the head office is included in the FY '35 to FY '40 liability there.
Okay. Income impact on financial statements and key metrics. So if you look at the balance sheet, we've shown you the IAS 17 closing balance sheet, the adjustments and the IFRS 16 opening balance sheet. On this page, effectively the impact by line, firstly, on the right-of-use assets and, of course, related to deferred tax with regard to that. The lease liability of ZAR 26.2 billion which is raised and the net impact on equity and NAV is a negative ZAR 3 billion based on the impact of the standard.
Right. And the next page is effectively just a graphical representation of that, net assets before IFRS 16 at ZAR 9.4 billion. After IFRS 16, on the far right, is ZAR 6.4 billion. We derecognize the operating lease accrual of ZAR 615 million. That's effectively the long-term portion and the short-term portion that you have to add up. We recognize the right-of-use asset at ZAR 19.7 billion. And then the lease adjustment and onerous lease provisions and the fair value lease adjustments make up the ZAR 1.564 billion; deferred tax, ZAR 1.265 billion; and then the new lease liability at ZAR 26 billion effectively recognized.
Okay. If we look at the income statement, again presented on an IAS 17 business basis. We've adjusted it for IFRS 16, the column in the middle, and then the impact after the adjustments. So very clearly, store and other operating costs are reduced because of the reversal of the lease expense, which is higher than the depreciation charge. So the net impact there is a positive ZAR 1 billion to operating profit. And then we bring in the finance costs of ZAR 1.5 billion, which reduces overall profitability -- overall profit before tax by ZAR 480 million.
And again, we presented this on the next page in graphical format. Adjusted profit before tax of ZAR 4.6 billion. We derecognize the rental costs. We recognize depreciation and finance costs. And aPBT comes in at ZAR 4.1 billion and the net impact is ZAR 480 million before tax. We've just spelled out -- because this is effectively looking back, we've just spelled out, at the bottom of that page, just some of the key assumptions that we have made with regard to reconstructing the income statement and the income statement effect.
Okay. And then moving on to the impact on key metrics. So starting with the income statement, EBIT, as I mentioned, is up by ZAR 1 billion from ZAR 5.4 billion to ZAR 6.4 billion. And that's because of the net impact of reversal of the rental costs. But bringing in depreciation, operating margin improves from 7.5% to 8.9%. Adjusted profit after tax reduces. And that's because of the interest that comes in. And overall HEPS is impacted by 9.3%. And that's a function of us being on average about 1/3 into our lease arrangements. You would expect obviously there to improve as we reduce our lease commitments and as our leases mature. Interest cover reduces because of the high interest costs. And that goes from 7.3x to 3.3x.
And then from a balance sheet perspective, net debt increases obviously substantially because of the lease liability. And that goes from ZAR 12.5 billion to ZAR 38.7 billion. Net debt-to-EBITDA increases as well from 1.6x to 4.7x. Just with regard to debts, key debt ratios and covenants, bank -- just to emphasize, that bank covenants are not impacted. IFRS 16 adjustments would be reversed for covenant purposes and on that basis, which banks refer to as frozen GAAP, so just to clarify that. ROCE obviously reduces because of the increased capital employed. And that's mainly as a result of the lease liability that they bring on. And then from a cash flow perspective, there are a few ins and outs here with regard to depreciation and operating lease costs. So EBITDA goes up by ZAR 3.6 billion of lease charges that gets reversed. Operating cash flow increases by ZAR 3.8 billion. And then free cash flow, just to emphasize, that remains unchanged.
So I think that brings us effectively to the end of the numbers. If I can just in closing just talk about the -- if this wasn't particularly clear, just to talk about reporting going forward. So FY '20 interim results, that will be done on an IFRS 16 basis, obviously. And what we will do is show it on a comparative IAS 17 basis to ensure comparability. And we will do that for the full year results as well. And then beyond FY '20, FY '21 will only be presented on IFRS 16 and that will obviously be comparable with FY '20.
And then just to -- again, just to talk about the recap of key messages, which is what I mentioned at the beginning. Firstly, with regard to the implementation and the methodology and the principles, we've covered that. There's a significant impact on financial reporting, the balance sheet, the income statement as well as key ratios. However, our financial fundamentals are not impacted. But there is an increased focus on reducing tenure and increasing the flexibility and variability of our lease agreements across the group. And then I mentioned that we are pursuing opportunities to optimize space across the group, especially given the structural changes that we are seeing with regard to online and also within David Jones specifically.
So that's the end of the formal part of the presentation. And I think there are a few questions that have come through online. So maybe we can answer those. So I'll give -- so Sue is here with me, [ Sue Hemp ]. And Sue's got the mic, and Sue will be asking me these questions.
Our first question comes from Renier de Bruyn at Sanlam Private Wealth. Will you be disclosing the lease liability repayments in the cash flow statement on a segmental basis?
Yes, we will. So...
Although we don't actually show a cash flow per segment. So it will be shown but not per segment.
Per segment, absolutely, yes.
Then a question from Bjorn Samuels at Argon Asset Managers. Reeza, thanks for the presentation and additional color on lease maturity profile per business unit. Am I right in assuming that any material store rationalization in David Jones would therefore only take place in 10-plus years, i.e., FY '30 to '35?
Bjorn, we have obviously communicated our intent to reduce our space by 20% by 2026. So we are pursuing opportunities beyond that as we speak. But the 20% is what we have in the system and that is aligned to lease maturities. And yes, we are pursuing other opportunities with landlords to reduce space and obviously our lease commitments.
A question from Chris Reddy at Mazi. Referring to Slide 5, what percentage of existing leases did you assume will be renewed at expiry? How does that differ per format, i.e., food versus clothing versus DJ?
We haven't disclosed that. But clearly within DJs, they are -- because of the space optimization that we are pursuing, there would be less stores that we would be renewing leases on. And in the case of food, which obviously is a business with still significant growth potential and performing well in flagship, especially flagship stores, we will be -- we have assumed the extension of, as a proportion, more leases in food.
A question from Jan Meintjes at Denker Capital. How did you treat the turnover-based leases in terms of the standard?
So the base rental is included in effectively your noncancelable portion of your lease. But the turnover-based -- the turnover bit is excluded from the calculation.
And will continue to be shown as an operating lease charge.
And will -- yes. And that is effectively shown in the income statement as operating lease costs, yes.
Another question from Renier at Sanlam Private Wealth. Will you be introducing new metrics to replace your operating margin targets?
I think we -- once we get through financial year 2020 and we go through our planning process for the next 3 years, we will clearly be -- I mean clearly, we will be having to introduce new metrics, as far as operating profits and the like is concerned. And I mean currently, we have adjusted certain metrics for the impact of IFRS 16. But this is the new world in which we are operating in. So we will -- it's inevitable that we will change our key metrics and how we measure them.
Thanks, Reeza. And that's all the questions we have from the webcast.
Okay. That's under half an hour. So thank you. Thank you, everyone. If there are any further questions, I'll be available as well as Sue, which -- who you can mail. And thank you for your participation this morning.
