After reaching an all-time high of approximately $37.71 in April last year, the price of Woolworths Limited (ASX: WOW) has gradually declined as negativity surrounds the retail giant. This has taken many investors by surprise as the last two decades has seen Woolworths become one of Australia's most reliable dividend-payers, widely held in both institutional and household portfolios.
However, it seems investors are starting to doubt Woolworths' ability to maintain its previous success. With the stock currently trading around $27, this represents more than a 25% discount on the share price this time last year. But are the company's prospects 25% worse? Investors need to consider whether the sell-off has been justified.
On face value, there is a lot to like about the retail conglomerate. Woolworths has only once, during the last 20 years, declared to shareholders an annual dividend yield of less than 5% (in 2007). Companies on the ASX sporting a dividend of equal reliability are few and far between. Woolies' success in maintaining distributions to shareholders can be attributed to its stellar track record of steady profit growth and its management team.
The ability to maintain that steady growth is largely due to outstanding defensive characteristics that bring in customers despite unavoidable downturns in market conditions. Its core revenue generator, the supermarket chain, has provided income stability through the GFC, oil crisis, high/low interest rates, and numerous other economic shocks. Regardless of these challenging events, consumers' need to purchase food and groceries results in a solid revenue stream during the best and worst trading conditions.
Unfortunately, the stock price decline is not entirely unfounded. There are a number of skeletons in the closet that have begun to place significant pressure on Woolworths' ability to maintain its market dominance.
Low-cost retailers Costco and Aldi have only just begun dipping their toes in the Australian retail market. Although their current market share is not a reason for Woolworths to sound the alarm bells just yet, their continued Australian expansion will place additional pricing pressure on Woolworths going forward.
The well documented struggle of Woolworths' home improvement chain, Masters, is also a point of consideration. Bunnings — owned by Wesfarmers Ltd. (ASX: WES) – continues to maintains its go-to status among consumers for professional and DIY hardware. Given its significant efforts thus far, Woolworths does not look to be standing down anytime soon, and it appears it will be persisting in its endeavour to gain market share in this space. There is reason to believe that Masters could become a turnaround success, however this will likely require significant and continual capital expenditure.
Foolish takeaway
For the better part of two decades, Woolworths has maintained its position as one of the leading ASX retail giants. Investors should not assume this previous success will simply continue uninterrupted, and should cautiously consider the notable headwinds the business faces in the short- to medium-term. If management is able to find the necessary solutions, as it has done diligently to date, Woolworths could very well be undervalued at today's prices.
