The Woolworths Limited (ASX: WOW) share price has rallied almost 10% in the past three months and is now back above $25.
But, as many Australians will know, Woolworths has been in the doldrums lately.
Indeed, over the past five years, Woolies has contended with falling profit margins in supermarkets, a costly Home Improvement business (which included Masters and Home Timber & Hardware) and competition within its General Merchandising business Big W.
As perhaps could be inferred from the chart above, shareholders have struggled through profit downgrade after profit downgrade.
But now with new management at the helm and the Home Improvement business sold off, some investors are likely to be questioning if it is time to revisit Woolworths as an investment.
Risks
Turning around a $33 billion supermarket business is not easy. And thanks to the divestment of Home Improvement, coupled with the ongoing struggles of Big W, it is easy to see why a meaningful turnaround in the company's share price may never come.
The fundamental problem for Woolworths is profit margin pressure, since it is a volume business. That means, it sells many products for a small profit. So if profit margins dropped to 4% from 5%, for example, that would be a 20% fall in profit. However, if they go the other way, it's a 25% profit increase.
Unfortunately, if Woolworths try to increase prices, they could continue to lose customers to Aldi, Coles, maybe Costco or even online.
Cutting costs and finding a speciality like the best fresh fruit, for example, may be what it takes to send Woolies' profit higher. But cost cutting only lasts so long. Morale falls and good people will go find work at Coles.
Foolish Takeaway
There may be value in Woolworths shares yet. But a return to $30+ could prove tough. I think the Woolworths share price could get there but to compensate for risk I would want to buy the shares lower than they are today. However, I'm not very confident in its future.
On the other hand, if you believe Woolies will return to the top of the food chain (pun intended) over the next five years, it could prove to be good value at today's prices.
