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Is the Woolworths Limited share price a buy?

The Woolworths Limited (ASX: WOW) share price has grown by 5% in 2017, is it a buy today?

Woolworths owns several businesses and the Woolworths supermarket chain is the best known among these. Other businesses include Dan Murphy’s, BWS, Big W and ALH Group hotels.

Woolworths is traditionally seen as a defensive, basic essentials business. However, I don’t think that investors should consider it as safe as it seems for the following reasons:

Competition

Woolworths and Wesfarmers Ltd’s (ASX: WES) Coles had a duopoly for a very long time. This allowed them to expand and generate some of the highest margins in the western world.

However, they no longer have free reign. Overseas competitors saw how much profit the Aussie supermarkets were making and wanted a piece of that retail pie.

Aldi and Costco are well and truly established here now. They have both taken a sizeable chunk of market share. Woolworths and Coles have already reduced their prices to reduce customer loss.

Margins

Reducing prices may retain customers but it’s bad for the profitability of the business.

In Woolworths’ half-year report to 31 December 2016 it reported that the supermarket earnings before interest and tax (EBIT) margin had decreased from 5.18% to 4.34%. This was a large factor in EBIT decreasing by 13.9%.

This is extremely important because Woolworths has to sell a lot more items just to make the same bottom line profit as before. If Aldi and Costco are taking most of the growth of the market then Woolworths’ profit and dividend aren’t going to grow any time soon.

Amazon

All of this happening without the presence of Amazon. Its arrival is imminent, but the troubles suffered by Woolworths have been present, even before the internet giant has set up shop here.

I expect that Big W is most at risk of early disruption because Amazon will be selling a lot of items similar to Big W’s offering.

Woolworths supermarkets have a fantastic distribution network which Amazon will find difficult to beat in the first few years. Amazon Fresh could be a competitor but it may be harder for Amazon to come to terms with Australia’s geography and population spread compared to the USA.

Amazon recently announced its intention of stepping up the pressure on supermarkets in the USA with its US$13.7 billion proposed purchase of Whole Foods in the USA.

Foolish takeaway

Woolworths does seem to be heading in a better direction than it was before. It was the right decision to shut Masters, it was the right call to lower prices.

However, there are so many things stacked against Woolworths’ long-term success that I would avoid investing. I wouldn’t consider investing in Woolworths unless its price was at least less than $20. It’s currently trading at 22x FY17’s estimated earnings with a grossed-up dividend yield of 3.77%.

Instead, I would want to look at these stocks that have much larger long-term potential and won't be competing with Amazon.

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Motley Fool contributor Tristan Harrison has no position in any stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. 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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