Woolworths: Value Now Or Not?

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

-Underestimating marketing need
-Relentless competition continues
-Questions over space expansion 
 

By Eva Brocklehurst

Woolworths ((WOW)) disappointed the broking community with its September quarter sales update, showing signs its competitors are pulling away in terms of growth. Sales growth of 3.9% compares with 5.8% at main rival Coles. Meanwhile, Woolworths' discount department store Big W is under pressure and patience appears to be wearing thin regarding when hardware chain Masters will become profitable. Petrol sales continue to be negatively affected by the competition regulator's fuel discount ruling.

What was there to like about the update? Macquarie observes the share price slump, and further de-rating relative to Coles' owner, Wesfarmers ((WES)),  presents a buying opportunity as the market appears to be pricing in a period of slower growth. Macquarie has an Outperform rating and $35.84 target. Deutsche Bank suspects Woolworths has underestimated the degree of promotion required to maintain its value perception with customers, particularly in dry grocery goods. This issue is addressable, in the broker' s view, and not a sign of any structural deficiency, as Coles' strong performance suggests the broader market dynamics are sound. Deutsche Bank also considers the bar has now been set low for the Woolworths share price and retains a Buy rating and $37.50 target.

This is not the case for JP Morgan, who questions the slowing in Australian food and liquor momentum and the fact the gap with Coles has widened again.The broker note the sales performance at Masters is weak and this suggests the path to profitability remains difficult. New Zealand supermarket sales are also soft and Big W's transformation is adversely impacting its sales. JP Morgan is concerned that Woolworths' efforts to expand earnings margins in the last quarter of FY14 and the first quarter of FY15 may have weighed on value perceptions and customer volume. Initially an advantage for Coles, the broker observes it is also advantageous to Aldi, a small but aggressive competitor.

JP Morgan maintains the liquor side is arguably the best business for Woolworths, but the company has been cautious about growth in that division and having been a strong performer, sales growth rates could moderate with a more subdued liquor industry. Price perception needs to be repaired, in JP Morgan's view, and this requires a marketing and/or price adjustment by Woolworths. Coles remains aggressively intent on value and this may hinder the effectiveness of Woolworths' marketing. Meanwhile, Aldi is growing in the background.

UBS suspects market share inroads have been made by discounters Aldi and Costco, with the third consecutive quarter of market share loss for Woolworths' food & liquor division. The broker suspects the re-launch of "The Fresh Food People" and the launch of "Cheap Cheap" have not resonated with the market as well as the company would have liked. UBS' recent study of the impact of discounters suggest they are highly efficient and offer compelling value and it is difficult for the major chains to compete.

Morgan Stanley believes Woolworths has done some of the damage to itself. Feedback from the industry suggests poor inventory management, declining fresh food displays and recent cost cutting initiatives are beginning to affect store performance. Morgan Stanley notes the Australian food & liquor division sustained its lowest volume growth in more than 12 years as food inflation ticked higher.

Supermarkets rely heavily on scale to reduce fixed supply chain costs and declining volumes are likely to lift the cost-to-sales ratio. The broker makes no bones about the acceleration in store roll-out. New stores are increasingly being rolled out in existing catchment areas and this simply leads to cannibalisation in Morgan Stanley's opinion. Eight supermarkets and nine liquor stores were opened in the quarter and Woolworths expects to open another 17 and four respectively in FY15.

Morgan Stanley is critical about increasingly relying on cost cutting and gross margin expansion rather than operating leverage to achieve profit growth. The company has not proven its credentials in retailing outside supermarkets, hence the broker remains unwilling to factor in value upside from non-supermarket businesses. In supermarkets it comes down to a "space race" with competitors and the broker is not impressed, retaining an Underweight rating and $30.00 price target.

On FNArena's database there are four Buy ratings, one Hold and three Sell for Woolworths. The consensus target is $35.51, suggesting 6.1% upside to the last share price. Targets range from $30.00 to $42.60.
 

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