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Top broker says dump Woolworths Group Ltd (ASX:WOW) and buy JB Hi-Fi shares

Our economy might be growing at its fastest pace since the mining boom, but now is the time to turn a little more cautious on the consumer discretionary sector, according to Macquarie Group Ltd (ASX: MQG).

The issue with the latest Gross Domestic Product (GDP) figure is that it’s backward looking and the 0.9% expansion in our economy in the June quarter (or 3.4% for the year) may be as good as it gets.

Macquarie has downgraded its recommended weighting towards the sector to “neutral” from “outperform” due to growing consumer spending headwinds and following the significant re-rating in the sector.

The S&P/ASX 200 Cons Disc (Index:^AXDJ) (ASX:XDJ) index of consumer discretionary stocks has surged over 9% since the start of this calendar year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up only 3%.

Retail has been a surprising outperformer during the reporting season, as I wrote last week (click here to see why), and while some still have a bright FY19 outlook, there’s no denying that the risks are building with some of our consumer-facing stocks looking overpriced.

One such candidate is Woolworths Group Ltd (ASX: WOW), according to Macquarie, particularly on news that it may consider divesting its gaming, hotel and liquor businesses into a separate entity.

“We struggle to see the financial/strategic merit of this given the elevated current P/E [price-earnings] multiple and likely complexity in splitting distribution/rewards between Supermarkets and Drinks,” said the broker.

While Woolworths has been de-rated recently, the stock is still trading on a FY19 underlying P/E of 21 times, based on Macquarie’s estimates, and the broker thinks that is too high, especially given its belief that consensus downgrades are looming.

The change in accounting standards on how leases are treated (AASB 16) is also a negative for Woolies as its pre-tax profit is likely to decline while its net debt to earnings before interest, tax, depreciation and amortisation (EBITDA) will jump from 0.4 times to 2.8 times, added the broker.

On the flipside, Macquarie thinks electronics and household goods retailer JB Hi-Fi Limited (ASX: JBH) is a bargain even after the stock rallied around 14% over the past month on a pleasing profit result.

“JBH remains compelling despite the bounce given a multi-year merger synergy tailwind and likely upside risk to FY19 as we cycle the weak performance of TGG [The Good Guys] in FY18,” said Macquarie.

The broker has a price target of $27.91 on Woolworths and $28.80 on JB Hi-Fi.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group 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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