According to the Chaos Theory, it is said that when a butterfly flaps its wings on the coast of New Mexico it causes a hurricane in China. The Chaos Theory does not propose that the butterfly literally causes a hurricane, but that a single action sets in motion a series of random events which leads to the hurricane occurring. Applying those principles to the share market, it can be said that a market crash in China may lead to a recession in Australia because of a series of unrelated events. This is why investor sentiment is currently turning fearful…
According to the Chaos Theory, it is said that when a butterfly flaps its wings on the coast of New Mexico it causes a hurricane in China. The Chaos Theory does not propose that the butterfly literally causes a hurricane, but that a single action sets in motion a series of random events which leads to the hurricane occurring. Applying those principles to the share market, it can be said that a market crash in China may lead to a recession in Australia because of a series of unrelated events. This is why investor sentiment is currently turning fearful towards Australian equities and sparking the 8% decline in the S&P/ASX 200 Index (ASX: XJO) since the start of the new year.
However, as with the Chaos Theory, certain occurrences are simply to preserve order and disorder in the world. With Chinese markets enduring disorder through last week’s savage sell-off, I believe any flow-on effects to Australia are to preserve market order and thus believe they should not have lasting effects on the ASX.
In light of this, investing in quality, Australian-focused companies like Woolworths Limited (ASX: WOW) for the long term should allow investors to see through the chaos and benefit when order resumes.
It is no secret that China is facing economic turmoil with demand for its exports diminishing amidst dwindling global growth. The country also faces structural issues with an ageing population, low commodity prices, a labour shortage and its transition to a consumption economy. All of this means China is unlikely to deliver on its 7% annual growth target, having ramifications for countries like Australia who are heavily reliant on Chinese demand.
To combat this, Chinese authorities decided to devalue the Chinese Yuan last week, sending ructions through Chinese stock markets and igniting a global sell-off in risky assets.
Whenever chaos comes, a silver lining can be found in the opportunities it brings. In this instance, I believe the opportunity lies in buying companies which are focused on Australia and unlikely to be affected by a slowdown in China. This brings me to Woolworths.
Woolworths is Australia’s largest retailer and the undisputed king of Australian supermarkets. Since hitting an all-time high of $38.92 in May 2014, Woolworths’ share price has slumped to 10-year lows as sales have slowed and concerns grow around Woolworths’ ability to retain market share against new foreign entrants. Over the same period, Wesfarmers Ltd (ASX: WES) owned Coles has grown sales and gained market share (at the expense of Woolworths), indicating underperformance by Australia’s leading supermarket chain.
Not reliant on China
Woolworths is the biggest supermarket in the Southern Hemisphere and controls a whopping 39% of the Australian food and liquor market. However, unlike raw commodity producers such as BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), who actively rely on China to buy its products, Woolworths is solely Australian focused. Its entire supply chain is based in Australia and the company sells its end product to Australians.
Importantly, its supermarket division sells non-discretionary goods (given groceries are essential to human life), making it a highly resilient business against changes to economic conditions. Accordingly, Woolworths’ core supermarket business should ordinarily be unaffected by massive gyrations in China.
However, as has been prefaced, this has not been the case in 2016 so far. Admittedly, Woolworths was not the best investment in 2015, with the stock plummeting almost 17% over the course of the year.
However, with Woolworths’ share price falling a further 10% since the start of 2016 alone, it appears oversold, especially when compared to peer Wesfarmers whose share price has dropped 5% over the same period (in line with the market fall). As such, all else being equal, Woolworths shares appear to be trading at a discount to the market – making them a solid buy at current prices in my opinion.
As with any cause and effect problem, if one looks hard enough, one is certain to find a link between two unrelated objects. If China continues to crash and Australia goes into recession, it is likely that all conclusions will be that China caused the recession.
However, as with anything, there are two sides to the story and long-term investing is about seeing through the chaos and reaping opportunities as they arise. With Woolworths being a business focused solely on Australia, the current problems with China should not materially affect its earnings and thus a purchase at current prices provides an excellent opportunity to buy a blue-chip company!
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Motley Fool contributor Rachit Dudhwala owns shares of Woolworths Limited. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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