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Is growth in Woolworths Group Ltd (ASX:WOW) set to accelerate?

Credit: Woolworths

There’s fresh signs that sales growth in the supermarket segment is about to accelerate as a key sales index for the sector has strengthened further in June.

The National Australia Bank Ltd. (ASX: NAB) cashless sales index pointed to an acceleration in growth of card sales at our supermarkets from 9% in May to 11% in June.

Morgan Stanley pointed out that this is the strongest monthly reading since the index started in 2017 if you excluded the Easter shopping frenzy in March this year and supports the positive retail sales data from the Australian Bureau of Statistics (ABS).

“Historically, there has been a link between the NAB cashless sales index and ABS category growth,” said Morgan Stanley.

“We think the drivers of faster industry growth is some cost push inflation, but also benign supermarket competition ahead of the Coles demerger slated for late 2017.”

Wesfarmers Ltd (ASX: WES) announced in March that it would spin-off its Coles supermarket business into a new listed company and Coles management has subsequently flagged that it was expecting profit growth in the second half of FY18.

This is significant because the upbeat profit outlook coincides with anaemic like-for-like (LFL) store sales growth that is barely keep up with inflation. LFL sales measures growth at stores opened for a year or longer.

What’s more, Morgan Stanley pointed out that costs are rising from higher energy and labour costs. The broker believes the growth will primarily come from higher grocery prices.

This in turn means that competition in the sector is easing and that is good news for all the supermarkets, including embattled Metcash Limited (ASX: MTS).

However, sector leader Woolworths Group Ltd (ASX: WOW) might be in a better position than Wesfarmers and Metcash because hardware and garden products sales are slowing with the NAB cashless sales index recording its fourth month of decelerating growth in June when sales in this category increased 7% compared to 8% in May, 11% in April and 13% in March.

But Morgan Stanley thinks Woolworths is overpriced and is recommending investors sell the stock.

“WOW now trades at its highest one year forward P/E [price-earnings] multiple in over 10 years (21.2x) based on consensus estimates,” said the broker.

“The last time (Dec ’07) it traded at this forward multiple the Food and Liquor business generated LFL sales growth of 6.8% (vs 3Q18 +4%) and EPS growth (FY08) was 23.8% (vs FY18E +12.3%).”

However, Woolworths is about to ramp up its investment in its stores to ensure that it can fight off the threat from low-cost competitors Aldi, Kaufland and Amazon.com.

Woolworths will need to spend big and show results for its efforts if it wants to keep its market premium. Buying the stock now is essentially backing a positive outcome from its capex program.

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Motley Fool contributor Brendon Lau owns shares of National Australia Bank Limited. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. The Motley Fool Australia owns shares of National Australia Bank 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 Scott Phillips.

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