Woolies The Defensive Staple

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

– Woolies delivers solid quarterly sales result
– Guidance reiterated, so only minor changes to earnings estimates
– Brokers attracted to defensive earnings growth
– BA-ML the only negative view following upgrade by Macquarie

By Chris Shaw

While a tough operating environment has forced the likes of David Jones ((DJS)) to lower earnings guidance, the non-discretionary nature of the core food and liquor operations of Woolworths ((WOW)) has allowed for the reiteration of full year guidance post June quarter sales results.

For the June quarter Woolworths reported a 5.4% lift in group sales when adjusted for Easter, the core food and liquor operations delivering like-for-like growth of 3.3%. The result was broadly in line with expectations, with Big W delivering the strongest result in boosting sales by 2.0%.

The Big W result was outstanding given the tough operating environment according to RBS Australia, especially when compared to the problems of David Jones. The main negative for Woolies was a rapid slowing in momentum in the consumer electronics business, something RBS suggests could have implications for the likes of JB Hi-Fi ((JBH)) and Harvey Norman ((HVN)). 

Post the sales result, Woolworths continues to guide to earnings growth of 5-8% for FY11, so there have been only modest changes to earnings estimates across the market. A subdued outlook for food inflation also limited the extent of any changes to numbers.

As an example, to factor in the sales result UBS has trimmed its earnings per share (EPS) forecasts for Woolworths by 0.1% this year and by 0.8% in FY12. Consensus EPS estimates according to the FNArena database stand at 174c this year and 189.8c in FY12. 

Price targets have also seen minor adjustments, the consensus target for Woolies according to the database increasing to $29.60 from $29.45. Targets range from BA Merrill Lynch at $23.50 to Credit Suisse at $34.00.

In most cases, brokers remain positive with respect to investing in Woolies, as evidenced by the database showing five Buys, two Holds and only one Underperform rating, this from BA-ML. Morgan Stanley also rates Woolworths as a Buy within an In-Line view on Australian retailers, while Goldman Sachs rates the stock as a Hold. 

Arguing the Buy case is UBS, which is attracted to the defensive growth on offer. The broker estimates Woolworths should deliver three-year capitalised annual earnings growth of around 9%, with earnings risk to the upside given consensus numbers appear to be pricing in too pessimistic an outcome for the food and liquor operations.

Citi also sees value, taking the view higher food inflation will at some point flow through and boost earnings. The stability of grocery demand and the concentrated industry structure also suggest limited downside even in the current tough retail market.

But BA-ML retains its negative view, the quarterly sales result doing nothing to dissuade the broker from the view Woolworths will increasingly find it difficult to boost returns on investment. As an example, the broker notes in FY11 total supermarket trading area expanded by 3.6% but total sales grew by just 4.3%.

On BA-ML's numbers, return on capital employed for Woolworths is likely to hit 17.6% in FY12, which would be well down from the 23% achieved in 2005. This is enough to suggest earnings growth in the next couple of years will be tough to come by, especially given the need to absorb start-up losses from the new Hardware business. 

Macquarie upgraded its rating on Woolworths post the sales result, but only to Neutral from Underperform. This reflects the view with Coles ((WES)) competing for the same customer, earnings growth is likely to be in the single-digit range in coming years. This means while value has improved, it isn't by enough to justify a more positive stance.

Shares in Woolworths today are stronger and as at 2.00pm the stock was up 28c at $27.73. Over the past year Woolworths has traded in a range of $25.52 to $30.18, the current share price implying upside of around 7% to the consensus price target in FNArena's database.
 

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