Many market commentators often describe Woolworths Limited (ASX:WOW) as simply a defensive stock, with an attractive dividend yield, as opposed to a growth stock. However, I believe Woolworths is not only a stock for investors seeking income, but it also offers a solid growth profile and is slightly undervalued despite the share price increasing by 25% over the past 12 months.
Woolworths should continue to outperform over the next 12 to 24 months as a result of high-single digit earnings per share growth. Growth in earnings per share over the medium term will come from the following factors:
1. An increase in food inflation after a prolonged period of low food inflation rates. Analysts estimate that every 1% increase in food inflation results in approximately a 2% increase to Woolworths' earnings. Economists have forecast a 2% increase in food inflation during FY15.
2. Further increases in grocery sales. The Australian food and liquor business makes up 80% of group earnings. An increasing store count, the maturing of recent new stores opened and new marketing and loyalty initiatives should drive solid increases in grocery sales.
3. Woolworths has incurred significant start-up losses from the rollout of its Masters home improvement joint venture with US giant, Lowes. However, losses from the joint venture will continue to fall over the medium term and the venture will likely be extremely profitable over the longer term.
