Australia | Apr 18 2007
By Chris Shaw
As reported yesterday the market’s initial reaction to the Woolworths (WOW) third quarter sales figures was fairly lacklustre and the stock was sold down by more than 1%. While further analysis has seen some minor upgrades to earnings and price targets and the stock has recovered yesterday’s falls, the question now turns to where do Woolworths shares go in the future.
According to the FNArena database the most likely direction is higher, as the stock is rated as Buy five times compared to three Hold and two Underperform recommendations.
Those with Buy ratings have a number of reasons why the stock will continue to perform well, related primarily to what has been strong operating performance and the potential to grow via acquisitions.
This growth through acquisition is likely to be two-pronged if all goes according to the plans of management, as it has expressed interest in acquiring the general merchandise assets of Coles (CGJ) as a boost for its existing Big W and consumer electronics operations domestically, while Warehouse Group in New Zealand remains another potential target.
Assuming nothing comes of the company’s interest in either target, ABN Amro suggests shareholders are likely to benefit from additional capital management initiatives.
In earnings terms as well the outlook is good, the broker estimating the company should record earnings growth of about 20% both this year and in FY08 thanks to ongoing strength in the food and liquor operations and the improvements coming through in general merchandise.
Merrill Lynch is similarly positive, suggesting the latest sales result shows the company is now leveraging its sales growth into earnings growth, which is even more impressive a performance given it comes from what is already a high base.
The broker estimates the company has a 400 basis point cost advantage over Coles and with the company having just completed a substantial investment program it sees little chance of the gap between the two changing much in the medium-term, even allowing for a more competitive performance by its rival. The broker suggests while Coles could well turn around, in the short-term there is likely to be an adjustment period to any new management team and Woolworths is well placed to take advantage of that.
The broker also sees upside potential from the company’s New Zealand operations, as performance there has not matched Australia and so there is scope for some improvement.
Currently Merrill Lynch sits at the top of market earnings forecasts at $1,342m for FY07, but it suggests the company should have little trouble achieving this number given it implies second half profit growth of 25% and it achieved 27% in the first half and sales growth should be stronger in the current six months. This sets the scene for upgrades to consensus forecasts, an outcome JP Morgan also expects in coming months and which it sees as providing support for the share price.
One dissenter to this positive view in the market is Macquarie, which rates the stock as Underperform and regards the stock as overvalued at current levels. The broker argues the strong sales result was directly related to the problems at Coles, implying a more focused Coles management team should be able to pare back some of the advantages currently enjoyed by Woolworths.
Credit Suisse agrees, expecting performance at Coles to improve once the ownership issue is resolved. Despite this view the broker has made minor upgrades to its earnings estimates for both FY07 and FY08 to reflect the latest sales figures, at the same time lifting its target price to $26.35 from $25.00.
The average price target in the FNArena database is $29.10, up around $1.00 from the target prior to the sales result, with Merrill Lynch leading the way at $35.00 and Macquarie the low rider at $20.90. The median price target according to Thomson One Analytics is $26.11.
Shares in Woolworths are stronger today, as at 3.10pm the stock was up 26c at $29.04.