UBS: Woolworths Group Ltd shares are a buy

Credit: Woolworths

Shareholders in Woolworths Group Ltd (ASX: WOW) and Wesfarmers Ltd (ASX: WES) can breathe a little easier as there are signs that the threat posed by Aldi supermarkets is waning.

UBS thinks that the rollout of stores by the German discount grocer in Western Australia and South Australia may actually not be as bad as many had feared on Woolies and Wesfarmers’ Coles supermarket chain.

However, the biggest winner from the latest assessment by the broker is actually Metcash Limited (ASX: MTS) through the IGA business – but more on that later.

UBS noted that the percentage of Woolies, Coles and IGA stores that are competing with Aldi in WA and SA is roughly the same as the more established east-coast markets even though the three have less than twice the penetration rate in the two states.

Some were worried that because Woolies, Coles and IGA had fewer stores in WA and SA, that Aldi would have greater opportunity to steal market share.

This doesn’t seem to be true and Aldi may have limited ability to open more stores in those two states because of the high rate of cannibalisation – or the number of Aldi stores that are stealing customers from each other.

The rate of cannibalisation has already reached around 63% in WA and SA even though Aldi has only recently entered those markets, according to UBS. This compares to circa 78% for the more mature east-coast market.

Metcash has the most to gain from this analysis as around 30% of its store footprint is in WA and SA compared to circa 18% for Coles and Woolies.

“While we have downgraded our FY18 market growth estimates to +3% y/y (prev. +3.5%), reflecting softer 1H18 trends (produce deflation), our analysis suggests competitive intensity is unlikely to worsen, giving us comfort for our forecast re-acceleration in market growth in FY19+ (UBSe +3.5% y/y),” said UBS.

The era of easy gains for Aldi appears to be over and the German challenger will need to work harder than before to steal market share from the incumbents.

It is also reassuring to see that there is no irrational pricing in the market where one rival tries to win customers by slashing prices to unsustainably low levels.

While this is good news for the whole sector, Woolworths is the only stock that UBS thinks is worth buying as the broker believes market consensus is underestimating the company’s earnings growth potential.

UBS has a neutral on Wesfarmers and Metcash, and it warns that Wesfarmers is at risk of missing market expectations on its earnings.

There is a sector that is facing much more favourable conditions though. The experts at the Motley Fool are particularly bullish about this niche sector as they believe the key players in this field will make a big splash on investment markets in 2018 onwards.

Click on the link below to get your free report on this sector and to find out what stocks should be on your watchlist for the year ahead.

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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 and has recommended 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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