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This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

This story was first published two days ago in the form of an email sent to registered FNArena readers.

By Rudi Filapek-Vandyck, Editor FNArena

Is Woolworths ((WOW)) a good investment?

I haven't exactly kept records, but I must have heard the question at least a few dozen times in the year past. As every cab driver who's driven me and asked the question can attest, my response has steadfastly been the same: depends on what you want. The shares are unlikely to shoot the lights out anytime soon, but there should be limited downside at around $27 per share and the company is expected to pay 4.5% in dividends this year, 5% in FY12.

To be honest, I didn't think Woolworths shares would fall much lower than $27, but my analysis was briefly put to the test when the shares fell as low as $25.50 in March. Now they're back above $27 and if recent weeks can be our guide, it seems investors are comfortable with this price level, despite the uncertainty that has crept into the general mindset post retailer David Jones' bombshell of a profit warning last week.

It seems I was correct as far as the limited downside is concerned. Woolworths shares today are about 38c (1.4%) higher than at the beginning of the year and pretty much unchanged since I published my analysis in late November last year. At the time, I wrote the shares seemed poised to generate 10-12% in total return (4.5% in dividends included). In the post-David Jones profit warning era, however, those numbers look a bit stretched.

At face value, Woolworths' performance doesn't look like much. Certainly, many an investor would question the wisdom of participating in the share market at all if this was all that was up for grabs, but the irony is, today, Woolworths shares have outperformed all major indices and the great majority of stocks that are included in these indices. In case anyone wondered: BHP Billiton ((BHP)) shares entered the new calendar year close to $46 (nearly 7% above today's price), while shares in Newcrest Mining ((NCM)), Australia's pre-eminent gold producer, were at the same price level as where they are today. Shares in David Jones have lost 30%.

Most investors might find the conclusion an understatement, but it has been tough going for the Australian share market ever since the rally from depression lows in March 2009 stalled in August-September that year. The ASX200 has in essence remained captured in between 4200 and 5000 and, post David Jones, it doesn't look like we're going to see a break-out anytime soon. To the contrary, experts now fear we are about to see a slaughterfest in August and September, with analysts expected to cut their earnings per share forecasts by double digits, in particular for domestically oriented stocks with little or no exposure to miners and their capital expenditure.

The general fear is now that after two years of lower than usual growth for most companies in the Australian share market, which has resulted in low to dismal growth for many domestic cyclicals, there won't be any relief in fiscal 2012. This then raises the obvious question: how much longer can this continue?

Economists at Westpac were the first mainstream forecasters to break ranks on Friday. Westpac thinks last year's November rate hike by the Reserve Bank has already proved to be the straw that broke the camel's back. Non-resources Australia is in recession, argues Westpac and certainly a profit warning as severe as David Jones's would only support such a conclusion. Yet, this doesn't automatically mean the RBA will soon start cutting interest rates to right what currently seems oh so wrong. There's still a mining and energy boom to deal with and if labour market data are correct, the market remains too tight for Reserve Bank comfort.

That's the problem with the situation in Australia today. Take away the Commodities Boom and the RBA would have little hesitation in starting to prepare for rate cuts to better balance the domestic economy. But things are far from normal. Which is why Westpac's view remains a stand-out today with many economists at leading stockbrokerages and elsewhere following up on Monday by stating they do not share the Westpac view.

This does not always have positive implications for investors.

Economists at JP Morgan, for example, have long abandoned any hope there will be a quick solution to the headwinds hanging in front of the Australian share market. Europe debt problems, sluggish growth in the US and continued need for tightening in emerging economies are poised to keep a lid on Australian equities, advocates JP Morgan. The previous target of 5000 by year-end has now been pushed out to June 2012. In its place has come a new target of 4750 for the end of the current calendar year, suggesting there's still room for a 6% rally in the five months ahead (ex dividends).

Oddly enough, market strategists at JP Morgan are not as gloomy on Australian domestic companies as Westpac and many others. They see value but no catalyst. With regards to official interest rates and government policies, both in Australia as overseas, they talk about a bad version of Goldilocks with dire situations probably not bad enough to trigger a change in interest rate policy settings while inflation remains a threat and overall earnings growth will likely prove just enough to support current share prices, but fail to push them much higher.

Over at Macquarie, strategist Tanya Branwhite is now looking for the next, short, sharp cycle. As reported previously, Branwhite has post-2007 formulated the vision that the world post-GFC is one of many shorter cycles, which should provide investors with multiple, non-lasting rallies for equities a la 1964-1981. As such, Branwhite is looking for what might remove the lid on resources companies and widen the performance gap between resources stocks and domestic industrials.

Within this context, Branwhite has not yet given up on a positive end outcome for the Australian share market this year, but trigger and relief will have to be derived from the international arena. The Macquarie strategist suggests there will be few positives domestically with profits likely to remain under stress and in a negative trend and with flow-on effects on confidence for both consumers and business leaders. Political blandness in Canberra is not going to make much of a change either.

Note that Macquarie differs in view from many peers by predicting that if the Australian share market is now awaiting severe cuts to earnings forecasts (as is now widely assumed) this will likely push the share market to lower levels, even if much of it has already been priced in.

While all of the above seems very doom and gloomy, there are still plenty of experts around who refuse to accept there are no better prospects around for Australian shares. Strategists at UBS stick to their view that all we are going through is a regular mid-cycle slowdown and investors should thus prepare for a rally between now and year-end. Similarly, Deutsche Bank retains an Overweight stance for resources and an Underweight rating for industrial stocks. Deutsche Bank observes how FX markets and most commodities continue to suggest the world is becoming a better place, meaning once we get through temporary headwinds, equities should once again enjoy their moment in the sun.

Deutsche Bank also observes industrials had been de-rated less than banks and resources in recent months, suggesting the market simply had it wrong and now this is being corrected. Top picks for the year ahead are WorleyParsons ((WOR)), NRW Holdings ((NWH)), Transfield Services ((TSE)), Adelaide Brighton ((ABC)), Woolworths, AGL Energy ((AGK)), Amcor ((AMC)), and Wesfarmers ((WES)).

Strategists at Goldman Sachs also appear less concerned about upcoming cuts to earnings forecasts. They differ from most in that they believe most cuts to FY12 forecasts will remain small and are already more than accounted for in today's low share prices. On Goldman Sachs's assessment (and apparently all analysts at the firm have been asked to make that extra effort) no more than 17% of all stocks under coverage appear to carry downside risks, while only 13% appears to have upside risk. This suggests the Australian share market will escape from all the doom and gloom scenarios with a Big Scare and with lots of stocks that are too cheaply priced for their earnings growth.

Stand-out stocks expected to show decent growth next year include, on Goldmans analysis, News Corp ((NWS)), Wesfarmers, QR National ((QRN)), Woolworths (!), QBE Insurance ((QBE)), Telstra ((TLS)), Macquarie Group ((MQG)), Brambles ((BXB)), Macquarie Airports ((MAP)), Lend Lease ((LLC)), Boral ((BLD)) and Asciano ((AIO)). The irony is, some of these stocks, such as Wesfarmers and Asciano, are also mentioned among the 17% with downside risks (supporting the stockbroker's view that cuts to forecasts won't take away the growth overall).

Let's put some numbers to all of the above. On current market forecasts, Australian companies will reveal an average EPS growth of circa 7% for fiscal 2011, while expectations are for 21% growth in 2012, of which some 17% goes to industrials. Those with a deeper concern, and thus a benign outlook for the share market, fear the first number might end up being negative, while the second will be cut by around 15 percentage points, leaving a single digit only. Goldman Sachs predicts EPS growth in FY12 will average 8% for industrials, which is well above the negative scenarios considered elsewhere, which then leads to the stockbroker targeting 5400 for the ASX200 by June 2012.

All shall be revealed in the upcoming reporting season. Alesco ((ALS)) will kick-off the local season on July 26. That's industrial, housing and renovations and a low valuation all in one. Current consensus expectations are for EPS growth in FY12 of close to 30%. The question as to how much of these projections will remain after the FY11 report release, provides the answer as to how cheap Alesco shares really are. (Note Alesco shares are currently projected to yield 6% in dividends in FY12).

(This story was originally written on Monday, 18th of July 2011 and sent in the form of an email to paying subscribers on that day).

P.S. Investors who'd like to re-read my Woolworths analysis from last year, see "It's A Bubble! (But Not The One You Think)" 

P.S. II – There will be no Rudi's View story this week and no appearance on either Sky Business or BoardRoomRadio as I will be presenting on the Gold Coast on Wednesday

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