Better Buy: Woolworths Limited vs Wesfarmers Ltd

It’s an intriguing question. Should investors put their cash into Woolworths Limited (ASX: WOW) or Wesfarmers Ltd (ASX: WES)?

The case for Woolworths

Woolworths recently reported something the market hadn’t seen in many years. Since the end of June, its supermarkets were recording positive same-store sales growth. While it was low, it could also be signs of the turnaround starting to take effect at the retailer.

The sale and closure of the loss-making Masters home hardware business will be one less problem for management to worry about.

Big W is still struggling, but it also may be primed for a turnaround. And a number of reports suggest Woolworths could sell off other non-core assets like its petrol stations.

The case for Wesfarmers

Coles has been steadily improving since Wesfarmers acquired it, with sales and margins growing. Bunnings – the home hardware business – is powering along, and the demise of Masters could see growth accelerate even more. Kmart appears to have turned around and while Target is still struggling, the person responsible for Kmart’s turnaround, Guy Russo, has been handed control over Target.

One big risk is Wesfarmers’ move into the UK home improvement market following the acquisition of Homebase in January this year. Some analysts have labelled it Wesfarmers own “Masters disaster”.

Here’s a brief summary of the two companies’ key financials.

Woolworths Wesfarmers
Revenues ($m) 58,085 65,981
Market Cap ($m) 30,664 47,962
Share price $23.98 $42.59
Earnings per share (cents)               123.3            209.5
P/E ratio 19.4              20.3
Dividend (cents) 77 186
Dividend yield 3.2% 4.4%

Source: Company reports

As you can see, they both look similarly priced, although Wesfarmers boasts the better dividend yield. The question is, are either of these companies worth buying at current prices? A P/E ratio of around 19-20x earnings for a stable, slow-growing supermarket retailer appears high – particularly given the threat from the low-cost discounters Aldi and Costco, not to mention a turnaround underway at Metcash Limited’s (ASX: MTS) IGA supermarket network.

When you consider investors can buy shares in other high quality companies such as Blackmores Limited (ASX: BKL), Servcorp Limited (ASX: SRV) or JB Hi-Fi Limited (ASX: JBH) for similar P/E ratios and arguably higher potential growth rates, it appears that investors would be better off passing on both companies.

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Motley Fool writer/analyst Mike King owns shares in Woolworths and Wesfarmers. You can follow Mike on Twitter @TMFKinga

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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