Woolworths – not so fresh!

Co-founder of the Switzer Report
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The big consumer staple stocks like Woolworths and Wesfarmers have been among the best performers on the market this year, as investors search for “low risk” yield. In fact, the sector is up by 17.7% in 2013, and Woolworths has done even better, with a gain of 21.3% to Friday’s closing price of $35.59.

However, with the forecast yield on Woolworths down to 3.7%, and the stock trading at a forward multiple of 18.9, it is starting to look expensive. Time to sell, or if you are not in the mood to take a gain, don’t buy, there is better value elsewhere.

The positives

  • Woolworths has a fantastic record of increasing earnings and dividends – it can almost be thought of as an “indexed annuity”. Earnings per share have increased over each of the last 10 years, and since 1993, Woolworths has maintained or increased its dividend each period. There are very few companies on the ASX that can boast this claim;
  • On a historic basis, Woolworth’s forward PE is not that high. Back in the heady days of 2006/07 when Woolworths had a huge lead over Coles, Woolworths traded at a multiple around 25;
  • While the Wesfarmers business mix is different to Woolworths, with interests in coal and insurance, Wesfarmers is more expensive, trading at a forward multiple of 21.6 for 2013 and 19.6 for 2014;
  • The sentiment indicator on FN Arena (a ratio of broker buy/sell/hold ratings) is marginally less negative for Woolworths and Coles.

The negatives

  • Woolworths is trading on a forecast yield of 3.74% in 2013, and 3.93% in 2014. Grossed up for the benefit of the franking credits, this is equivalent to a yield of 5.34% and 5.61%. While interesting, ING Direct is offering a two-year term deposit paying 4.80% per annum – government guaranteed;
  • According to consensus forecasts from FN Arena, WOW is trading on a forward PE multiple of 18.9 in 2013, and 17.9 in 2014;
  • Although the gap has closed, Woolworths is still being beaten by Coles in sales growth. In the last quarter, Woolworths grew sales (on a same store basis, adjusted for Easter) in food and liquor by 4.9%, Coles by 5.3%;
  • Woolworths’ move into home improvement (hardware), through the Masters stores, might be encountering more challenges than expected.  Losses are expected on this business over the next few years.

The bottom line

In this bull market, Woolworths will probably trade higher on a PE basis. However, on a relative basis, Woolworth’s yield of 3.7% doesn’t stack up against Telstra yielding 5.6%, or the major banks, which are yielding between 5.0% and 5.5%. Coles has the sales momentum, there are question marks over the WOW move into hardware, and on a risk-adjusted basis, the two-year term deposit from ING Direct looks reasonably compelling. I prefer others.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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