5 reasons to avoid Woolworths Limited shares

Credit: Woolworths

In investing there is a concept called the inflection point. The inflection point represents the point at which the worst has already happened, and the future from that point on will be brighter.

For investors, picking the inflection point for a beaten-down stock can be hugely profitable. If you can invest at precisely the moment all of the bad news is priced in, but before the broader market becomes aware of the coming recovery, you would be placed to reap the full rewards of the recovery.

It is common for journalists and analysts to label a fallen blue-chip as a “turnaround stock” on the basis that it must eventually return to its former highs. For Woolworths Limited (ASX: WOW) those highs were close to $38 in mid-April 2014, some 45% above current levels.

But there are several reasons why Woolworths may not be at its inflection point yet.

Smashed on same stores sales

Woolworths supermarkets have had a rough few years, with same store sales being consistently outpaced by Wesfarmers Ltd (ASX: WES) owned Coles stores.

The most recent quarter showed that this trend continues unchecked, with Coles’ comparable sales rising 4.8% for the quarter, while Woolworths’ supermakets actually fell by 0.9% in the same quarter.

Same store sales are the key metric for retailers. New stores give a “purchased” uptick to overall sales, but same store sales are a better indicator of demand for the products and service offering, and a gap this big is a huge danger sign.

Foot on the throat

If you wind the clock back a few years, the roles of the two supermarket giants were reversed. Woolworths was dominant while Coles was the basket case. However, Woolworths made a crucial mistake: it maintained or raised its margins on products, rather than reinvesting in lower prices.

That meant that when Coles came along with its “Down Down” price strategy, there were plenty of opportunities to establish a big price differential between the two supermarkets.

In turn, that led to shoppers migrating away from Woolies to Coles, and has been a major factor in the same store sales numbers. Now that the roles are reversed, Coles is showing no signs of repeating the mistake of its rival. Prices are continually being lowered on key basket items, entrenching Coles as the better value option of the two in shoppers’ minds.

General merchandise – generally terrible

If the supermarket sales look bad, then the general merchandise sales of Big W look diabolical. Same store sales at the chain are down 4.5% for the quarter. That looks even worse when stacked up against Kmart’s 15.2% increase on the same measure.

No green shoots

The current state of Woolworths supermarkets indicates that management is still trying to plug the leaks in the boat, rather than being able to steer it, or set a new direction for growth.

In situations like this it is advisable to search for tangible evidence that the negative trends are slowing or reversing, rather than investing and hoping that a turnaround is imminent.

Stagnant investments

Even Woolworths management concede that any turnaround will take between three to five years to take hold. In a rapidly changing and dynamic stock market, that is far too long for capital to sit idle.

However, the great thing about the stock market is that there are literally thousands of other options to invest in. There are currently several that are well worth consideration today that present far more attractive risk and reward propositions than Woolworths.

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Motley Fool contributor Ry Padarath has no position in any stocks mentioned. 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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