Is this analyst right on Woolworths Limited?

This morning while reading through the daily “buy” and “sell” recommendations issued by analysts at major stockbroking firms, I noticed one analyst had a “sell” recommendation on Woolworths Limited (ASX:WOW). What struck me most about the recommendation to sell Woolworths was not so much the recommendation itself, but rather the reason behind it. The analyst stated that:

 “Woolworths plans to open 35 new supermarkets in the next three years, while Coles plans to open 20 new stores. On average, the Woolworths stores will be smaller than the Coles outlets, and they will be located in smaller population areas.  While the Coles stores will be in new catchment areas, the new Woolworths stores appear to be cannibalising its existing network”.

Is this really a valid reason to sell your Woolworths shares? I would argue it is not. Let’s look at some facts:

1. Over the past 10 years, the share price of Woolworths has increased by 211%, excluding the growing dividends received by investors along the way.

2. In respect of third quarter sales figures for FY14, Woolworths achieved a 5.2% lift in grocery sales, which was ahead of rival Coles.

3.Woolworths is Australia’s largest grocery retailer, with around a 30% market share. The outlook for the Australian and New Zealand grocery market appears favourable given the level of consolidation in the sector, the strong pricing power Australia’s two major supermarkets have over suppliers, and Australia’s increasing population growth. Analysts forecast that the Australian supermarket sector will continue to grow at approximately 5% over the medium term.

4. Woolworths will continue to benefit from increasing food inflation. Food inflation has been at historically low levels over recent years, however food inflation should continue to improve over the medium term, providing strong earnings growth. Analysts forecast that for every one percent increase in food inflation, Woolworths earnings increase by two percent.

5. The business will continue to see improving cashflow over the coming years as a result of reduced capital expenditure.

Woolworths is one of the safest long-term investments on the ASX. The company provides reliable, defensive earnings growth and an increasing dividend. Investors should be wary of analysts’ recommendations as they tend to be focused on the short term.

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Motley Fool contributor Bradley Murphy owns shares in Woolworths mentioned in this article.

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