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Top broker thinks now is the time to buy shares in Woolworths Group Ltd (ASX:WOW)

The share price of Woolworths Limited (ASX: WOW) is outperforming today after Citigroup upgraded the stock and predicted a pick-up in sales growth.

The stock jumped 1.4% to $28.12 during lunchtime trade compared to a 0.5% increase in archrival Wesfarmers Ltd’s (ASX: WES) share price to $49.67, a 2% drop in Metcash Limited (ASX: MTS) to $2.98 and a 0.1% gain by the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index.

However, Woolworths’ share price is still down 7% over the past three months as investors sold off the stock on the back of market share gains by Wesfarmers’ Coles supermarkets due to the latter’s highly successful Little Shop campaign.

“Coles LFL [like-for-like] sales growth has experienced a remarkable turnaround in growth in 1Q19e. We expect LFL sales growth to accelerate to 5.0% due to Little Shop and giving away free plastic bags,” said Citi.

“This has come at the expense of Woolworths, where LFL sales growth is likely to moderate to 1.5%.”

But this campaign has run its course (although Coles is promising to bring round two of its Little Shop promotion back in 2019) and that means Woolies sales will be bouncing back as the latter is better at managing its stores and has a more proven management team, claims the broker.

What’s more, grocery prices appear to be rising and that’s good news for sales growth. Price competition from offshore challengers like Aldi had been particularly painful for Woolies and Coles, but pressure on this front is easing.

Citi believes that Coles has reduced the average price discount by around 3.5 percentage points (ppts) during the Little Shop promotion with the number of products being discounted dropping by around 0.7 ppts. What all this adds up to is around a $23 million uplift to Coles’ gross profit.

Woolies has exercised great restraint as it ceded ground to Coles during the Little Shop campaign by not attempting to cut prices. This means its average price discount fell around 0.7 ppts during this period, according to Citi.

More importantly, this paves the way for more rational price competition between the supermarket majors going forward, although the peace may not last as German discount supermarket Kaufland is about to enter the Australian market and may rely on intense promotions to gain an initial toehold.

But that’s an issue for another time and isn’t enough to stop Citi from upgrading Woolworths to a “buy” from “hold”. In contrast, the broker has reiterated its “sell” call on Wesfarmers.

“Woolworths has de-rated to 18x (including Petrol) one year forward PER following a soft trading update,” said Citi.

“We expect 3% LFL sales growth to resume in 2H19e, supporting high single-digit earnings growth over the next three years and a $32.00 target price.”

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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 Scott Phillips.

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