With the market appearing to have cast off its concerns over Greece's economic predicament, it has been a great start to the new financial year (FY) for the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
The two-day rally has lifted a number of blue-chip stocks including the beaten-down Woolworths Limited (ASX: WOW). Given FY 2015 was disastrous for Australia's largest retailer – the stock finishing around 25% lower – shareholders will be hoping for better times ahead.
The new FY has certainly got them off to a great start with a 3.3% rally so far. The gains will no doubt have investors asking the question whether now is a good time to buy…
Based on consensus data provided by Morningstar, Woolworths is forecast to earn 182.2 cents per share in FY 2016. With the share price currently trading near $27.80 this implies a price-to-earnings ratio of 15.25x. On the face of it, that's a pretty appealing multiple and compares favourably with the market average PE of 17x.
So, from a pricing perspective there is definitely a reason to be positive about the opportunity to purchase one of the ASX's top blue-chip stocks at a discount to the wider market, however, there are also reasons to be wary…
Firstly, some leading brokers have 'taken the knife' to their outlook for the company with the ABC reporting that at least three major broking houses have slashed their price targets (PT) for the stock with one broker's PT standing at just $21. This could create a significant drag on any recovery for the share price in the near term at least.
Secondly, the industry is in the midst of structural challenges. Already investors have seen the effect this has had on grocery wholesaler Metcash Limited (ASX: MTS) whose business is struggling in the face of competitive pressures and whose share price is trading at a decade low and down around 60% in the last 12 months.
Thirdly, there could still be a long way to go before a new base level of earnings is reached for Woolworths. While the current consensus forecast implies a mild dip of about 6% in earnings over the next year, this could prove to be too conservative or indeed be followed by further declines in FY 2017 and beyond. This is a big concern as it would more than likely lead to more downgrades for the stock.
