Many have weighed into the fall of Woolworths Limited (ASX: WOW), arguing that the stock is a bargain at today's prices or, conversely, that recent falls are just the beginning of a swan-dive as competitive pressures take their toll on profits.
So with Woolworths' shares trading just under $29, are they a bargain or not?
Here are three of the biggest assumptions investors should bear in mind:
- Food and liquor margins will fall meaningfully below recent levels for the foreseeable future
- The current annual loss in Masters of $200 million per annum needs to be either turned around or removed via sale
- Discount supermarkets like Aldi are niche players, not directly substitutable for Woolworths
It seems a given that investors can expect lower profit margins as competition from Wesfarmers Ltd (ASX: WES), Aldi and Metcash Limited (ASX: MTS) forces Woolies to sharpen its offering.
However, Woolworths has a lot of wriggle room before its margins reach that of competitor Coles (owned by Wesfarmers), whose margins hover around 4%. It remains to be seen just how far margins will have to fall to regain sales momentum and market share.
The oft-made assertion that Aldi is not replacing Woolworths or Coles is an interesting one, given Aldi's recent attempts to undermine the majors' advantage in fresh produce, a key differentiator between the stores.
On the other side of the equation, Woolworths and Wesfarmers are reducing their prices and increasing their investment in businesses like pre-cooked meals, directly challenging one of Aldi's staples. Part of the battle will be getting customers through the door – because they will naturally pick up a handful of other items while they're there – and it seems to me that increasing the convenience of Woolworths and Coles supermarkets would not be a bad strategy.
Aldi would appear to have the lead in convenience and price at the moment, but Woolworths and Coles are plenty capable of trimming that back.
Finally, the elephant in the room is Masters Hardware. Elimination of this segment's massive losses is vital to any argument that Woolworths' shares are undervalued right now. The trouble is that while the situation is improving, Masters doesn't appear to be tangibly closer to profitability.
I believe the hardware business is a great opportunity, as indicated by Home Timber and Hardware (Woolworths' other hardware chain), but Masters is an anchor on any valuation since its losses won't vanish overnight and I would prefer to avoid a sale of the business. Factoring in substantial losses from Masters into the equation, I agree with fellow contributor Owen Raskiewicz who valued the company recently and concluded it was worth less than $30.
Over a longer timeframe of 10 years or so and assuming Masters' eventual profitability, Woolworths does indeed look to be good value at today's prices. However, over the near term the stock doesn't look to be as good an opportunity as I expect investors will see further impacts from Masters, shrinking margins and the company's competitive woes.
