Why I think smart investors should buy Woolworths Group Ltd shares

Credit: Woolworths

Woolworths Group Ltd (ASX: WOW) might surprise some as my best share to buy now, but I believe this under-loved supermarket still represents value in a market where I am struggling to see many enticing opportunities in the large cap space.

CEO Mr. Brad Banducci was appointed in February 2016 to turn around the company following its failed Masters venture, and there have been positive signs of change under his leadership.

The group’s latest half-year result showed a substantial jump in performance compared with the previous corresponding period, however Woolworths Group Chairman Mr. Gordon Cairns stated there is still “significant opportunity for further improvement.”

Group net profit after tax (NPAT) rose an impressive 37.6% against the same period last financial year, driven by strong earnings momentum from the Australian Food, Hotels and Petrol segments. Woolies is still hoping to sell its petrol business to BP, even though the segment enjoyed a 27.9% increase in earnings before interest and tax (EBIT) for the period.

New Zealand Food and discount department store Big W detracted from earnings, with Woolies set to continue to invest in the businesses. Big W “continues to be a multi-year turnaround”, with a $10 million EBIT loss for the period expected to blow out to between $80 million to $120 million for FY2018.

Once seen as a relatively safe, solid yield stock, Woolies was forced to slash its total dividend from $1.39 in 2015 to $0.77 in 2016, due to the fallout from Masters. The subsequent improvement in performance has led to an increasing distribution, with this year’s interim dividend higher by 26.5%.

The balance sheet remains in reasonable shape and would be further strengthened by the potential sale of Woolies’ petrol division. That strength, combined with improving earnings and strong cash flow generation, means I don’t think it will be too long before Woolies is once again considered a high-quality dividend stock.

The current share price may look expensive on a trailing price to earnings ratio, but that is because last year’s earnings were so low. On a forward-looking basis, I believe Woolies is currently trading at less than 20x FY2018’s earnings per share.

Foolish takeaway

Woolies’ performance has been steadily improving even as Australian retailing conditions are stifled by high household debt and low wage growth. We have seen generally strong corporate results this earnings season, which I believe will eventually result in wages growth and higher consumption.

Although turnaround opportunities remain for Woolies in the short-term, I believe improving economic conditions and population growth will provide performance tailwinds over the medium-term.

Having recently gone ex-dividend and now retreating from 12-month highs, I believe the Woolies share price may continue to decline over the next few weeks and would be good value around $25.

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Motley Fool contributor Ian Crane owns shares of Woolworths Limited. 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 Scott Phillips.

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