Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn


Why you’re paying too much for Woolworths

Emma Rapaport  |  20 Aug 2019Text size  Decrease  Increase  |  
Email to Friend

Shares in Australia's largest supermarket shot to near five-year highs this week, boosted by demand for defensive stocks, but Morningstar analyst Johannes Faul says Woolworths is significantly overvalued.

Investors have been flocking to Woolworths (ASX: WOW) this year, sending the company's stock price up 20 per cent to highs of $36.09 today. This is the stock's highest level since October 2014.

Woolworths (WOW) | 1 Year Stock Chart

Woolworths stock price

Source: Morningstar Premium

The strong performance is due to several factors including the company's decision to return $1.7 billion in funds to shareholders in an off-market buyback, following the sale of its petrol business.

Investors also responded well to Woolworths’ decision to pull the pin on pubs and pokies, sending shares up 2.7 per cent in the days following the announcement.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

Woolworths announced in July its intention to merge it bottle shop business, Endeavour Drinks, which includes Dan Murphy’s and BWS, and hotels and gaming-focused joint venture, AHL Group. The combined entity is earmarked for divestment in calendar 2020.

But with shares trading at 28 times earnings, Faul believes the company is expensive. The stock is trading today at a 43 per cent premium to his fair value estimate of $24.50.

Struggling to justify WOW's high P/E multiple

Faul says Woolworths is a defensive stock and well positioned to withstand cyclically weak consumer spending. Food and liquor generate the bulk of group revenue and profit, it has a solid balance sheet and a narrow moat surrounding its economic profits.

However, he believes the grocer looks expensive, especially when compared to its nearest competitor the newly separately listed supermarket giant Coles (ASX: COL) not to mention international peers such as Tesco and Kroger.

"We estimate Woolworths is worth $24.50 per share, and we see earnings at $1.29 per share in 2020. At our fair value estimate of $24.50 that implies a multiple of 19 times," Faul says.

"So we value Woolworths at 19 times P/E, which is higher than what we intrinsically value Coles at (which is 18 times), which is even higher than what Morningstar values UK market leader Tesco (which is 10 times), and Kroger, the United States' largest supermarket chain (12 times).

“If you look at the price you're currently paying, versus earnings, it's huge.

"But then you can say well Morningstar is bearish on Woolworth's 2020's earnings. OK, well let’s take the market price, and the consensus, the overall market, all estimates for 2020, and even then, Woolworth's screens as expensive versus peers.”

Global supermarkets comparison

Woolworth v international peers

Source: Morningstar

Ongoing structural challenges

Ultimately, Faul thinks Woolworths will struggle to expand margins in an increasingly cut-throat market.

"Woolworth's is trading at a 25 per cent premium to Coles, now the question is do you really expect growth in Woolworths to be that much better?" he says.

"The market is implying that Woolworths is going to have a lot more growth than Coles. But the question is: how are they going to get there? Either your cost structure gets better, and that will expand margins, or you grow market share, which means they have to take it from someone.

"At the end of the day, supermarkets are competing on prices, and that's exactly what Woolworths is doing too."

Faul expects several structural challenges to hurt long-run profitability, most notably the effect of online grocery sales

"For one, the ongoing strong growth in online food sales at close to 30 per cent--in line with Coles--is increasingly earnings before interest and taxes margin dilutive," he says.

"Further, we expect price-cutting to be a continuing feature of the Australian food retailing industry, at least in the near term.

"Woolworths is grappling with intense competition from its key competitor Coles, along with Aldi, and soon Kaufland, in the discount channel, and online from Amazon."

Woolworth's are due to report their full year earnings on 29 August 2019.

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend