Without Masters is Woolworths Limited a SELL?

After soaring 4% yesterday, the Woolworths Limited (ASX: WOW) share price today lost its mojo and headed down 4% before recovering to trade around 2% lower.

Following on from Monday’s announcement that it intends to part ways with its Home Improvement business, which includes the Masters and Home Timber & Hardware brands, Woolworths’ shares surged higher. Wesfarmers Ltd (ASX: WES), the owner of Bunnings Warehouse, and Metcash Limited (ASX: MTS), the owner of Mitre 10, each followed suit.

However, it now appears the market has lost yesterday’s enthusiasm and has sold down shares of all three companies.

For Woolworths, the decision to sell its entire Home Improvement business is somewhat bittersweet.

On the one hand, Woolworths will be ridding itself of an asset that has continually produced losses despite receiving an investment of around $2.8 billion in four years. Thanks to the decision, group profit will improve markedly as a result of no more losses from Masters, but also thanks to less capital expenditure.

On the other hand, bullish investors may perceive that they have lost a key growth market for Woolworths over the long term. The home improvement market in Australia is enormous, growing and highly fragmented, so the potential of Masters and Home Timber & Hardware was substantial over the long term if they could’ve got the offering right.

Bunnings Warehouse, the most successful DIY chain, generated profit before tax and interest charges of $1.1 billion last year. However, it is certainly worth noting, that it has been operating for more than 20 years. Masters is less than five years old.

Unfortunately, Woolworths is also losing the war of the retail space, with Big W losing its battle with Kmart, and Coles (also owned by Wesfarmers) outperforming Woolworths’ supermarkets in recent years. Therefore, it’s somewhat unsurprisingly the new team at Woolworths decided to pull the pin on Masters.

Are Woolworths shares a SELL?

According to Dow Jones Newswires, analysts at Morgan Stanley, Morgans and Deutsche Bank raised their price target on Woolworths shares, which are currently priced at $23.10. However, the average price target set by those three investment banks is only $22.96.

What do I think?

In my opinion, the announcement that it’ll seek to sell its Home Improvement business in 2016 was a poor one. I think the Big W brand, which is mildly profitable and rumoured to also be on the chopping block, would be a far better divestment because it lacks the long-term growth prospects of the Home Improvement business.

Moreover, Big W’s profitability (it made $114 million operating profit in 2015 – down from $191 million two years earlier) makes it an easier sell than the Home Improvement business. Private equity firms would likely be licking their lips at an opportunity to gut another retailer like Big W before reselling it to less informed or ill-advised investors on the share market. Big W may fetch as much as $1.5 billion at auction, according to analysts.

Back in the Home Improvement business, it’s important to note that Home Timber & Hardware is still profitable and sales grew 17% in the first quarter of 2016. Further, new format Masters stores were showing a significant improvement in their operations, with sales climbing 23.5%. In fact, the new format stores exceeded old format store sales by over 30%.

Buy, Hold or Sell?

My estimates of Woolworths’ value relied on Masters becoming profitable in 2018. Without Masters, my assessment of the company’s valuation does improve in the short term, although not materially.

I sold some Woolworths shares from my family’s portfolio last week after sustaining heavy losses over the past year. While I still have some exposure to it, I now know why Wesfarmers deserves to trade at a premium to Woolies and why many analysts say it is a better buy.

Woolworths is still a great company, but without Masters and Home Improvement, it is only just hanging on as a hold in my book.

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Motley Fool writer/analyst Owen Raszkiewicz does not have a financial interest in Woolworths. Owen welcomes your feedback on Google+, LinkedIn or you can follow him on Twitter @ASXinvestUnless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks 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 policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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