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Macquarie Group warns the market’s got it wrong on the Woolworths share price

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The Woolworths Group Ltd (ASX: WOW) share price is rallying for the second day since the supermarket giant posted its quarterly sales update but at least one top broker thinks the market’s enthusiasm is misplaced.

The Woolworths share price jumped 1.2% in morning trade to a new four-year high of $32.60 when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index slipped just under breakeven and rivals Coles Group Ltd (ASX: COL) share price is up a modest 0.3% to $12.94.

The WOW share price gained nearly 1% yesterday after management reported a 3.6% increase in comparable food sales and a 4.4% improvement in comparable sales from its embattled Big W department store.

Why investors are excited

That’s a very pleasing result in my view given that Coles like-for-like sales was 2.4% and Big W is showing signs that the worst could be over.

“The WOW 3Q19 sales release was impressive with all divisions slightly ahead of expectations and a welcome return to some inflation in Food,” said Macquarie.

“Overall, consistent with industry feedback WOW is doing better than COL and ahead of our estimates.”

When strong sales aren’t enough

But that wasn’t enough to get into Macquarie’s good books with the broker reiterating its “underperform” recommendation on the stock with a 12-month price target of just $26.84 per share.

“Despite the strong performance, WOW highlighted extensive cost pressures in the business from suppliers, wage costs (January 2019 EBA +3.2%) and energy costs,” said the broker.

“We do not believe this strong sales growth will translate into profit growth. With online sales also growing 42% in the quarter, this will also be dilutive to group margin in isolation.”

There are also cracks in the Big W story even as the retailer reported robust sales. Macquarie also doesn’t think this will translate into better profits with this division tipped to produce a loss of $80 million to $100 million compared to last year’s loss of $110 million.

“This was a good sales quarter from WOW with strength across Food, Liquor and Big W,” added Macquarie.

“Despite this, we remain cautious on operating leverage here and at 23x FY20 EPS we see little value in WOW.”

Macquarie isn’t the first to express concern about Woolworth’s relatively high valuation. This is why some prefer Coles Group although I have to add that investors always have to pay more for quality and Woolworths’ outlook appears brighter than Coles.

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited and Woolworths Limited. The Motley Fool Australia owns shares of and has recommended COLESGROUP DEF SET. The Motley Fool Australia has recommended Macquarie Group 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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