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Why this broker thinks Woolworths Limited shares are a buy

An eerie calm seems to have blanketed the supermarket battle ground with the likes of Woolworths Limited (ASX: WOW) managing to claw back lost ground from real and perceived competitive threats.

But don’t be fooled into thinking the war is over. The supermarket wars may just be moving in to a new phase.

The share prices of our dominant supermarket players have been under pressure over the past few years as German grocery discount store Aldi marched into new geographies to set up shop within striking distance of a Woolies or Wesfarmers Ltd (ASX: WES) owned Coles supermarket.

But this first phase of the war, which is to seize territory, is coming to a close according to UBS as store rollouts have reached a saturation point.

This means growth in new stores will be in-line with population growth moving forward compared to the past when it was running at around 1.5 times population growth.

The broker observes that about 80% of supermarkets are within a 10-minute drive of each other and it believes that even Aldi stores on the east coast are starting to cannibalise each other at a rate similar to its more established arch rivals.

The slowdown in store rollouts during the supermarket battle has led to less discounting as prices have started to stabilise. We are now entering a period where the warring parties will be regrouping to reinforce their territories with smaller catchment sizes.

However, this isn’t quite the case for South Australia or Western Australia as Aldi has only just started moving into those geographies. UBS estimates that these markets will account for around 30% of incremental industry store growth and that the real loser from this is Metcash Limited (ASX: MTS) through its IGA chain.

But don’t be fooled into thinking the war is over on the east coast. Aldi is aggressively embarking on a store refurbishment program called “Aldi 2.0”. The new stores give more space to fresh food and this has led to an increase in foot traffic and average customer spend of between 6% to 8%. That is pretty impressive growth considering the type of growth Woolies and Coles are expected to deliver.

UBS thinks Woolies is on a recovery path and has a “buy” recommendation on the stock after it appears to have bottomed a year ago in the low $20s, and has a “neutral” and “sell” rating on Wesfarmers and Metcash, respectively.

I think the recent turnaround in Woolies is commendable and probably gives the stock some space to run higher, but I wouldn’t buy into our nation’s largest supermarket operator as there are other quality stocks operating in sectors with less headwinds to choose from.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Wesfarmers Limited. 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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