Why the worst isn’t over for Woolworths Limited shareholders

Credit: Woolworths

Shareholders of Woolworths Limited (ASX: WOW) may want to strap themselves in for a rough ride, because the worst mightn’t be over for the embattled retailer.

Woolworths reported its earnings results for the 27-week period ended 3 January 2016 on Friday last week, and the results were not pretty. It booked a loss of $972.7 million, down from a $1.98 billion profit in the prior corresponding period, plagued by a $3.25 billion impairment related to the closure of its Masters home improvement business.

To make matters worse for long-term shareholders, it also cut its fully franked dividend by more than a third to just 44 cents per share.

Although they dipped sharply on Friday morning, Woolworths shares actually rose for the day and have gained another 2.9% today to trade at $22.99. That could perhaps relate to the uncertainty being lifted over the future of its dividend, while it could also be attributed to the appointment of the group’s new CEO, Brad Banducci, who investors hope can turn the struggling business around.

It won’t be a quick fix…

Unfortunately for shareholders, who have watched their shares plunge more than 40% since May 2014, this won’t be an overnight fix. Some analysts expect at least one more year of losses while others aren’t expecting a recovery until 2019, according to The Australian Financial Review.

While Woolworths won’t have the burden of its Masters business dragging on its earnings results during that time, it has an arguably greater problem in the form of its core supermarkets business.

Although Woolworths still controls a dominant position in Australia’s grocery channel, it is losing precious market share to the Wesfarmers Ltd (ASX: WES) owned Coles, together with international discount retailers Aldi and Costco. In response, Woolworths is being forced to drastically cut costs and improve efficiencies in order to make its product pricing more competitive.

At this point, that is having a dramatic impact on the business’ margins, which could continue to fall as it lowers prices and losers customers. Indeed, the company itself isn’t expecting a significant improvement in the current half while a proper turnaround could take years to eventuate.

Should you buy?

Investors have long been told to invest in high-quality businesses when they’re trading at cheap prices. While investors should always be on the lookout for such opportunities, it’s also necessary to look at the fundamentals of the situation and ask why the market has sold the shares down so heavily.

In this situation, the market’s selloff of Woolworths Limited has been justified. Several poor earnings results and some terrible decisions by management have eroded some of Woolworths’ competitive advantages and put it in a very vulnerable position to attack from competitors.

While Woolworths could be worth a closer look in the future, I think it has a long way to go before it can prove it’s back on the right track. Until then, further disappointments could be punished by investors which could drag the Woolworths share price even lower than it is today. It’s worth a position on your long-term watchlist, but I wouldn’t buy just yet.

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The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Costco Wholesale. Motley Fool contributor Ryan Newman has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. You can follow Ryan on Twitter @ASXvalueinvest.

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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