Motley stock of the week: Woolworths

It is one of the Australian success stories of the last 20 years – the supermarket chain that was rescued from mediocrity and now turns over in excess of $55 billion in sales each year.

To put that in perspective, that’s the equivalent of more than $2,400 for every man, woman and child in Australia. Yes, the company does own businesses in New Zealand, but it’s still an astonishing number.

It’s $7,250 per household – or $140 per week.

The definition of ubiquity

Whichever way you look at it, it’s hard to miss the grocer-cum-publican-cum-hardware store proprietor. To say it dominates the retail landscape in Australia comes very close to understatement.

Woolworths (ASX: WOW) owns its namesake grocery stores, Countdown supermarkets in New Zealand, the Woolworths Liquor, BWS and Dan Murphy’s bottle shops, Woolworths/Caltex petrol stations, Big W, Master’s home improvement stores and (in some circles, controversially) a network of hotels.

The company truly has a finger in many, many pies – notwithstanding its recent divestment of its Dick Smith Electronics.

Frustrated by a lack of buyers, Woolies has also recently decided to spin off the SCA Property Group to shareholders, as well as offering units to retail investors.

A resurgent competitor

There’s no doubting the company’s dominance. However, a resurgent Coles – owned by Wesfarmers (ASX: WES) is making up some lost ground, showing Woolworths a clean pair of heels over the past few years when it comes to sales growth.

Unusually for Woolworths, it was beaten on marketing and Coles’ appetite to compete on price. The decision to sell private label bread and milk for $1 each was a masterstroke, and its “Down, down” advertising campaign also helped address the widely held consumer perception that Coles was a more expensive place to shop.

Despite Coles’ undoubted success, Woolworths underlying performance remains strong. It has delivered top and bottom line growth, and is investing heavily in its hardware joint venture as it looks for new growth avenues.

Looking for growth

There’s no doubt that Woolworths best days – at least in compound growth terms – lies behind it. Much of the work it did to grow its market share and improve profitability in the food and liquor market has already borne fruit. Shareholders will continue to benefit from those improvements, but further gains of the same magnitude in the same short time are simply unavailable in its core business.

That’s why the company moved aggressively into home improvement – it was a category of sufficient size and opportunity to make a difference for the retailer. One of the most difficult things for a company like Woolworths is that each opportunity taken reduces the pool of opportunities that remain.

The elephant in the room is obviously international expansion. While Woolies has done a good job of ‘sticking to its knitting’, there will be a stark choice for directors and investors in the years to come. They will either have to accept lower growth or higher risk if the company decides to strike out overseas.

I don’t want to paint too bleak a picture – this is one of Australia’s highest quality companies, with a strong management team and wonderful businesses. Management will continue to drive sales higher and costs (as a proportion of sales) lower. I believe the company will do everything it can to get every last ounce of growth out of its operations. That will provide a very solid base for shareholders, but significant compound profit growth (from its core business, at least) will be tough to achieve.

Foolish takeaway

I have confidence that Woolies will continue to grow into the future, with its management finding ways to maximise shareholder returns. That’s a reassuring thing, and a reason many Australians own shares in the company.

For a business with a lower growth future than its past, though, we need to be careful not to extrapolate that past into the future. At current prices, I think Woolworths might struggle to beat the market indices in the medium term.

Instead, it’s a business that should have pride of place on every investor’s watch list, and snapped up when the market suffers its regular bouts of pessimism and offers you the shares on the cheap.

If you only invest in one company this year, make it our “Top Stock for 2012-13”. Operating in two hot markets — one set to double by 2012, the other predicted to grow 5x over the next five years — this stock is a solid growth play that also boasts strong recurring revenue, zero debt, and lots of cash. Get its name and full research case in this brand-new FREE report.

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Scott Phillips is an investment analyst with The Motley Fool. He owns shares in Woolworths. You can follow Scott on Twitter @TMFGilla. Take Stock is The Motley Fool Australia’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691).

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