Getting The WOW Back, Slowly

This story features WOOLWORTHS GROUP LIMITED. For more info SHARE ANALYSIS: WOW

 – Woolworths delivers solid Q4 sales result
 – Price deflation remains an issue
 – Brokers at odds

By Chris Shaw

Woolworths ((WOW)) yesterday reported June quarter sales and the result was generally well received by the market. Core food and liquor sales rose 3.8% in total and by 1.3% on a like-for-like basis, the latter in particular better than expectations for an increase of around 0.5%.

As noted by Deutsche Bank, the improvement in the food and liquor division came despite no real improvement in food price deflation. The gains came from an increasing fresh produce contribution and strong liquor sales according to UBS, while the broker notes Big W also delivered a stronger result in part as a result of a government assistance package to households.

Deutsche viewed the sales performance as reasonable given the challenging operating environment and the broker expects further improvement in coming months. This is based on the view comparable numbers become easier, fresh produce price deflation continues to dissipate and re-branding delivers some benefits.

A return to price inflation at some point is inevitable in the view of Deutsche Bank and this should deliver meaningful operating leverage when it does eventually occur. JP Morgan agrees, suggesting the Q4 sales result cold be the start of a broader improvement for Woolworths, particularly as volume growth showed some positive momentum in the period.

On the back of the sales result brokers have adjusted earnings estimates for Woolworths, with modest increases to earnings per share (EPS) forecasts the general trend. As examples, JP Morgan has lifted its EPS forecasts by 0.3% for FY12 and by 0.8% for FY13, while Credit Suisse's numbers have risen by 0.2% and 0.7% respectively.

Consensus EPS forecasts for Woolworths according to the FNArena database now stand at 178c for FY12 and 190.8c for FY13. Changes to forecasts have seen price targets also revised higher, the consensus target for the stock moving to $27.51 from $27.11. Targets range from BA Merrill Lynch at $22.00 to Macquarie at $30.67.

The range of price targets highlights a range of broker views on Woolworths, as the FNArena database shows the stock is rated as Buy four times, Hold twice and Sell twice. JP Morgan supports the Buy argument, suggesting management is executing on a turnaround plan at the same time as the company's defensive earnings are attractive in the current environment. RBS Australia agrees, pointing out even though operating conditions are not ideal for Woolworths the company should still deliver EPS growth in FY13 of 10%. 

UBS retains a Neutral view on Woolworths, suggesting while momentum is improving near-term margins are likely to remain constrained given an accelerated store roll-out program. This is likely to limit the potential for any earnings surprise in FY13, which suggests little in the way of any potential positive share price catalyst.

Goldman Sachs is not in the FNArena database but also rates Woolworths as Neutral, this reflecting its view trading remains challenging and price deflation continues to limit earnings growth as the sales per square metre numbers recorded by Woolworths continue to decline.

Credit Suisse goes further and maintains an Underperform rating on Woolworths, the broker seeing little scope for outperformance given still competitive supermarket conditions. To grow supermarket revenue growth in FY13 additional costs with respect to service and loyalty are likely, which implies some downside risks to supermarket earnings over the medium-term.

BA Merrill Lynch agrees, taking the view price deflation and weak consumer sentiment will not only be ongoing but will likely worsen going forward. This suggests little scope for a significant re-rating for Woolworths in the broker's view.

Shares in Woolworths today are up in a weaker overall market and as at 12.20pm the stock was 5c higher at $27.94. Over the past year the shares have ranged between $23.21 an $28.15, the current share price implying downside of around 2% relative to the consensus price target in the FNArena database.

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