Woolworths Limited or Wesfarmers Ltd: Which should you buy?

Retail kings Wesfarmers Ltd (ASX:WES) and Woolworths Limited (ASX:WOW) continue their hardware battle for market share, squeezing more independent operators out of the market.

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Retail kings Wesfarmers Ltd (ASX: WES) and Woolworths Limited (ASX: WOW) continue their fight for hardware market share, but around them other retailers are struggling. General retail trade has been subdued since the mining pullback. Compared to the 9.4% gain of the S&P/ASX 200 Index (ASX: XJO) (Index: ^AXJO) in the past 12 months, Wesfarmers trudged along with a 1.1% share price rise. Woolworths fared worse, with an embarrassing 18.9% fall.

The strong competition between the two has squeezed independent hardware store operators, forcing some to close their doors. Others were bought out by the two retail giants in their drive for market share. The Australian Financial Review reported the number of independent stores fell 12.6% over the past two years.

Part of Woolworths' problem is the ongoing losses generated from its Masters home improvement and hardware stores. Despite racking up double-digit revenue growth in the first half, this division lost about $40 million more than the $71.9 million loss in the same period a year ago.

The fast rollout of new Masters stores has now been slowed to reduce losses until the business model can start turning an operating profit. There are about 34 Masters stores open now, going up against 324 Bunnings Hardware stores operated by Wesfarmers.

As much as Bunnings is successfully holding the market leader position, it only accounts for about 18% of the home improvement market, which is estimated to generate about $45 billion in revenue. Masters comes in at just under 2% of market share. Metcash Limited (ASX: MTS), the operator of the Mitre-10 and True Value hardware store chains, holds less than that.

Woolworths' drive to build up a rival DIY hardware chain over the long term is costing it heavily now. One retail analyst from BAML was recently reported by The Australian as suggesting the retailer get rid of the Big W and Masters store chains and concentrate on its successful supermarket business. If it did, the analyst estimated Woolworths stock would be trading around $67 instead of near the current $30 level.

I think over the long term Woolworths can work out its Masters earnings problems, but in the short term it has to start showing shareholders the rate of loss is shrinking, not expanding. Woolworths' plan to cut about $500 million in costs to make its supermarkets more competitive could be part of that turnaround.

Long-term investors will still want to hold Woolworths shares and even add to positions while the stock is down. Still, I favour Wesfarmers more since the conglomerate is said to have plans to expand into financial services, which may generate another income stream with decent returns.

Motley Fool contributor Darryl Daté-Shappard does not own shares in any company 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 policyThis article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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