Australia | Jul 11 2007
By Greg Peel
Supermarket giant Woolworths (WOW) was posting pretty good sales results this time last year. But almost to a man analysts suggested that the market was overstretching valuation. One even dubbed Woolies “the most expensive supermarket in the world”. It was hard to find anyone willing to put a Buy rating on the stock.
Not helping was the fact that petrol prices were very high, and interest rate hikes had begun. While the staples of bread and milk rarely suffer under such circumstances, there was no reason why shoppers wouldn’t start cutting back on their weekly trolleys, and on their liquor consumption and petrol indulgence. There was, it seemed, very little reason to overweight Woolies.
The stock was flirting with $20 at the time, and twelve months and four spectacular sales results later, here we are pushing $30. The tune has changed from the analysts, who now rate the stock 5/4/1 on the FNArena B/H/S scale. (We’ll come back to that single Sell in a minute) At $29.81 the average target is still some 6% above yesterday’s close.
And as testament to the magic of Woolies, in a rare occurrence every single broker in the database issued a report this morning.
There is no doubt that Woolies has achieved a lot of its spectacular results through an all out assault to lift sales. But the reality is that the real drivers of success over the past twelve months have a lot to do with sensible acquisitions and the capitulation of one GJ Coles & Company (GCJ). Analysts fell off their chairs when they read that the Food & Liquor sales growth result of 8.2% (some noting this was the highest comp figure ever achieved in the history of ever), but compared to other market sectors sub-10% growth is pretty run of the mill. There was further good news in that Big W continues its turnaround and Consumer Electronics faired okay.
The result only sparked one broker to upgrade its rating, as Credit Suisse – seemingly defeated – moved from Underperform to Hold. But there were no movements elsewhere. While the supermarket sales result smacked plenty of gobs, profit guidance did not.
Woolies had originally guided for 20-24% profit growth in FY07, and upgraded to 25-27%. Not a bad result for a seller of milk and bread, but considering some analysts had their forecast figures at over 30%, it was a disappointment. It clearly disappointed the market in general, which dumped on the stock yesterday, and continues to do so today (albeit in a weak market). What went wrong?
Was it a higher level of transitional costs? asks Credit Suisse. Increased price reinvestment? as JP Morgan suggests. Or was it, as Merrill Lynch offers wryly, a form of creative accounting?
Merrills reports that Woolies could have achieved profit growth of 35-40% if it wanted to, but as such would risk booking a “trophy” profit in a year when the main opposition was acting like a train crash in slow motion. The risk is that one rests on ones laurels, only to report lower “comps” the following year. So while there was no doubt a bit of a hit from increased costs, Woolies did invest heavily in reducing prices, but it was more a case of spending hard when the tin was full in order to not look bad next year.
But why would Woolies be worried about looking bad? Virtually every analyst threw their “overstretched multiples” call out the window some time in the last six months and suggested Woolies could happily trade on whatever multiples it wanted to – so dominant was its position. There are still 5 out of 10 brokers calling a Buy.
But one broker is calling a Sell, and it feels that Woolies is in trouble unless it can secure Coles’ general merchandising business, as it would like to. Mind you, Macquarie downgraded about $10 ago, so one might be forgiven for suggesting that the team of Dring, Kovacs and Melnyk couldn’t call a cab at the moment, let alone the Woolies share price.
Nevertheless, the team is stoic. And it stoically suggests that Woolies had such a good FY07 – a “trophy” year as Merrills puts it – that it is unlikely all the stars could possibly align again in FY08. Coles will not be writhing in its death throes in FY08. There will not be any really good acquisition targets left. Woolies is not going to blow anyone’s mind on sub-10% sales growth.
That’s why Woolies must win the battle over Wesfarmers (WES) and force the dismantling of Coles. It cannot buy Coles as it is, given the competition restrictions. Wesfarmers appears to be almost sitting pretty now that private equity has pulled out, but is Woolies planning its assault?
Under Macquarie’s scenario, it might still be a very good time to own Coles. But if Woolies can’t get in and scavenge the bits it wants, it won’t be a good time to own Woolies.
Five other brokers disagree.