There aren't too many shares on the ASX that divide opinion more than Woolworths Limited (ASX: WOW).
The business may own the supermarkets of the same name, but it also owns hotel business ALH Group, Big W and liquor businesses like Dan Murphy's & BWS.
It used to run the Masters hardware chain, which could have been a very promising business, but management closed it because of mounting losses.
Wesfarmers Limited's (ASX: WES) Coles and Aldi have taken chunks out of Woolworths' market share over recent years, which is one of the reasons why the share price has dropped from $37 to today's $25.
However, the market is getting excited by Woolworths seemingly turning around its ailing supermarkets. In the last few updates sales growth has been positive, albeit not amazing.
For the first 14 weeks to 1 October 2017 comparable sales for 'Australian Food' were up 4.9% compared to the first 14 weeks in FY17.
Don't get me wrong, sales growth is better than declining sales. However, I think the price Woolworths are paying to achieve this growth isn't being fully appreciated by the market at the moment.
In FY17 Woolworths' sales grew by 4.5% compared to FY16, but earnings before interest and tax decreased by 2.4%. If the same trend is continuing in FY18 then Woolworths may report a better top line, but a worsening bottom line as it has to lower prices and advertise more just to maintain market share.
Foolish takeaway
I believe the market is overestimating Woolworths' turnaround and that it won't translate into bottom line growth, which is ultimately what we as investors need to concentrate on. The fact that Big W is also having difficulties doesn't help this, I think profit growth will be hard to come by this year.
Woolworths is currently trading at 20x FY18's estimated earnings, which isn't cheap at all for a business that could go backwards over the next year or two.
