MENU

3 reasons I think the Woolworths Limited share price is overvalued

Credit: Woolworths

The Woolworths Limited (ASX: WOW) share price has grown by 15% over the last three months, but is it a buy?

Woolworths owns the supermarket under the same name and it also owns Dan Murphy’s, BWS, Big W and ALH Group. Woolworths has a market capitalisation of $34 billion.

Here are my three reasons why I don’t think Woolworths is a buy at this price:

Supermarket margins are declining

The supermarket may have seen sales increase by 2.8% in its half-year results to 31 December 2016, but the earnings before interest and tax (EBIT) declined by 13.9%.

The profit margins achieved are extremely important when the Woolworths supermarket revenue figure is over $18 billion. Management are making more commitments to reduce prices, so I can’t see margins increasing any time soon.

The supermarket’s decline is a large reason why the earnings per share of continuing operations declined by 18% and the dividend declined by 22.7%.

Other businesses are not helping much

The Endeavour Drinks Group (which contains Dan Murphy’s) saw EBIT grow by 3.1%. This is a respectable result, but only resulted in an additional $9 million EBIT to add to the group’s total.

The New Zealand Woolworths business saw EBIT fall by 4.5%. Big W saw EBIT fall by 137.3% to a loss of $27.2 million.

There is no strong profit growth by any Woolworths business. At least Wesfarmers Limited (ASX: WES) has both Bunnings and Kmart growing earnings strongly.

Increasing competition

Woolworths is going to see increasing competition for its businesses. Aldi, Costco and potential other newcomers will challenge margins even further. Kmart, Amazon and other international stores will challenge Big W even further.

Without investing significant amounts of money, I cannot see a way for several of Woolworths’ businesses to break out of the current malaise.

Foolish takeaway

Woolworths is currently trading at 22x FY17’s estimated earnings, which is quite expensive for a company whose main business is going backwards. It has a grossed-up dividend yield of 3.63% which isn’t very high.

I think Wesfarmers is a much better buy than Woolworths at these prices. However, I wouldn’t buy either of these retail giants. Instead, I’d want to go shopping for these three strong blue chips.

A Big, Fat, Fully Franked Dividend

This company's dividend is almost the stuff of legends. Since it started paying dividends in 2007, it has increased its payout to shareholders every single year, a run that includes 21 consecutive dividend increases.

Based on the last 12-months of dividends, its shares are currently offering a fully-franked 4.8% yield, which grosses up to almost 7% when those franking credits are included. And in stark contrast to the likes of Commonwealth Bank and Telstra, this company just increased its dividend by over 13%, and guided for 2017 profits to grow by 20%!

Discover the name of this "new breed" of blue chip along with 2 others in our new FREE report "The Motley Fool's Top 3 Blue Chips Stocks For 2017."

Click here to receive your copy.

Motley Fool contributor Tristan Harrison has no position in any stocks mentioned. 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.

HOT OFF THE PRESSES: My #1 Dividend Pick for 2017!

With its shares up 155% in just the last five years, this ‘under the radar’ consumer favourite is both a hot growth stock AND our expert’s #1 dividend pick for 2017. Now we’re pulling back the curtain for you... And all you have to do to discover the name, code and a full analysis is enter your email below!

Simply enter your email now to receive your copy of our brand-new FREE report, “The Motley Fool’s Top Dividend Stock for 2017.”

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.