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Should you buy shares in Woolworths Limited today?

Woolworths Limited (ASX: WOW) shares are currently trading just 10% above their 52-week low and around 40% below their 2014 all-time high.

Could the stock offer compelling value at present?

There are certainly some reasons to be positive towards Woolworths shares today. Here’s the bull case…

It’s possible that financial year (FY) 2016 captured all of the decline in earnings and dividends with the company entering FY 2017 on a sounder footing.

For the 12 months ending June 30, profits from continuing operations before significant items slumped 39% to $1.56 billion. Earnings per share (EPS) fell by a similar percentage to just 123 cents per share (cps) and the dividend was chopped by nearly 45% to 77 cps.

These were massive declines for what is meant to be a blue-chip company.

According to data provided by Reuters, the analyst consensus EPS expectations for the next two financial years show growth.

Based on consensus forecasts, it could be reasonable to argue a bull case that a new base has been set from which the company will consolidate and grow.

This base has been achieved via Woolworths’ investment in lower prices, better service, and an improved store experience. These initiatives have been expensive and led to lower margins, but were necessary to restore the group’s competitiveness against peers Aldi, and Coles owned by Wesfarmers Ltd (ASX: WES).

Given the dividend pay-out ratio was just 63% (based on the above operating figures), investors could reasonably expect that the current dividend is also maintainable. With the stock trading at $22.50, the trailing fully franked dividend yield is 3.4%.

However, there are also a number of reasons to remain wary of the stock. Here’s the bear case…

As Woolworths’ CEO, Mr Brad Banducci, recently noted:

“While we are seeing early signs of momentum, we are not underestimating the size of the task that lies ahead, especially given the highly competitive nature of the markets in which we operate. As we have consistently said, this is a three to five year journey.”

The CEO’s comments are far from bullish and while a lot of pain was taken in FY 2016, there could still be further pain ahead which could see margins shrink even further.

Further tightening of margins is a real possibility considering that competition is only going to intensify as Aldi rolls out even more stores across its network.

Another leg to the bear case for Woolworths lies in its limited options for growth.

Having clearly made two very poor investment decisions with regards to the EziBuy acquisition (which recorded a loss of $15 million last year) and the disastrous Masters roll out, expectations that Woolworths can successfully apply its retail experience to other business operations are low.

Bull or Bear?

In my opinion, both the bear case and the bull case for Woolworths is quite strong which makes the investment case for Woolworths very difficult.

On balance however, I’m inclined to avoid the stock for now given management chose not to provide guidance for FY 2017, citing “the lack of visibility”. If management doesn’t have the confidence that it knows where the company is headed, then it’s hard to have faith in analyst consensus estimates for growth.

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Motley Fool contributor Tim McArthur 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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