Why you should sell Woolworths Group Ltd

Citibank recently upgraded Woolworths Group Ltd (ASX: WOW) to a “buy” status, citing a positive recovery for the company after the Masters home improvement failure which resulted in a major dividend cut. Citibank sees Woolworth’s core business as improving gradually and the business returning to the profitability levels it achieved 5 years ago.

However, I think this analysis is short-sighted. Woolworth’s stock is definitely not a “buy”. Let’s take an in-depth look at the business to understand why.

Firstly, Woolworths continues to lose money on its Big W operations which posted another $150 million dollar loss last year.  Management does not see any improvement in 2018 and Big W looks set for another major loss. Retail has intense competition and with companies like Kmart and Target posing a serious threat. It is not clear if the department store will ever achieve profitability.

Woolworth’s comparable store sales growth has also been very low. Increases continue to be in the very low single digits, with comparable items per basket actually decreasing fractionally. Margins, which are already tight at 4.7% actually declined to 4.4% this last financial year. Just like Big W is facing intense competition on the retail side, Woolworths is also facing significant pressure in their core food business, citing Coles and Aldi as placing significant pricing pressure on their food operations.

While Woolworths pursued so many different lines of business, they neglected their core food business. The company was slow to open new stores and refurbish existing ones, meaning that they lost market share to a number of competitors and didn’t put enough emphasis on the superior quality of their food, which has always been a major selling point for the company. Luckily, some of the company’s other lines of operation have proven to be more successful. Both the drinks and hotel business are profitable and generate enough free cash flow to offset the losses incurred from Big W.

Management is a major worry to me as a potential investor. They dropped the ball on the Master’s operations, costing shareholders millions of dollars. Woolworth’s has also been unable to sale their service station network as it was blocked by the ACCC in December of last year. Leadership does not seem to have any sort of clear plan to turnaround the Big W plan, there seems like no indication of spinning off the franchise anytime soon or selling it off somehow. This lack of direction really worries me as a potential investor and makes me think that there is no clear plan in place to reverse what has been a very expensive affair.

The most important reason not to purchase Woolworths stock is the company’s valuation, which is extremely expensive relative to future cash flows. Woolworths is trading at 16 times next year’s earnings in a very competitive market space. The company also incurred a $3 billion dollar write-off in 2017 and actually lost $1.6 billion dollars. As some core parts of its business need to be restructured, further write-offs might be incurred which would serve as a significant hindrance for profits.

Foolish Takeaway:

I believe you should sell any stock that you own in Woolworth’s Group Ltd. The company is selling at a very expensive valuation relative to its earnings, management and the sector it operates. There are better places to invest your money.

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Motley Fool contributor mpinto has no position in any of the 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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