- Woolworths' Q3 update pleased in that it confirmed an uptrend in the making - Some stockbrokers suggest this could be the catalyst for the share price - Macquarie remains skeptical

By Greg Peel

Consumer staple leader Woolworths ((WOW)) reported sales growth of 5.1% in the March quarter – a result which largely pleased analysts. While the result did not differ terribly much from analysts' estimates, the point is there were a number of reasons why the results may have surprised to the downside in this particular March quarter.

Firstly, Easter usually falls in the March quarter but not this year, so sales of chocolate eggs and bunnies and hot crossed buns were not providing their usual boost, despite displays being established on Boxing Day. So adjusted for Easter, the result was actually 5.6% growth.

More difficult to estimate is the impact on sales from the various natural disasters across the country (and in New Zealand) occurring in the quarter. Even without flooded supermarkets, Australians have been reluctant spenders since the GFC and consumer weakness has impacted heavily on the retail industry. In staples, rare food deflation has also proven an issue over recent quarters. And finally, rival Coles' ((WES)) grimace-worthy Status Quo campaign (Down, down, prices are down) has forced Woolies into making similar price cuts on several lines.

In short, the scene was potentially set for Woolies' dubious turnaround in sales growth, as exhibited over past quarters, to be completely derailed in March. But it was not to be. Even removing sales of now more expensive petrol leaves Woolies with 4.1% growth and this has led brokers to suggest the long awaited consumer rebound is finally beginning. Easter will bolster June quarter sales and food deflation is set to morph into food inflation given soft commodity prices have risen beyond the impact of the stronger Aussie dollar (food inflation is a positive for supermarkets because we all still buy the food anyway).

Analysts have been critical of Woolies' response to the Coles onslaught. To simply match its rival in price cuts has shown little imagination, albeit there appeared to be little impact in the numbers. This likely implies that despite supermarket spin, the real losers on price cuts are indeed the suppliers. While Coles is expected to mark similar sales growth numbers when it reports tomorrow, as its phoenix story rolls on, Woolies had previously been left behind by its revived rival. It would seem the gap is now closing.

Which is all good news, but then the question is as to whether, at yesterday's closing price, Woolies is showing value.

The stock is trading on an FY12 price/earnings multiple of 13.9x, calculates Deutsche Bank, and the analysts suggest this is fair value. Deutsche has thus maintained Hold, but it is the only broker of eight in the FNArena database on such a rating.

Morgan Stanley (not in database but Overweight) points out the rather obvious – the last time Woolies was trading on a forward multiple this low was more than ten years ago. Who can forget the heady days pre-GFC when, to analyst amazement, Woolies' PE just kept pressing higher and higher, to 27x and beyond? They were the glory days of course, when the moves into petrol and liquor were having their impact and rival Coles was quietly going down the gurgler. So the likelihood of seeing those numbers again is very low.

Credit Suisse (Outperform) nevertheless agrees that at 13x and a free cashflow yield of 7%, Woolies is indeed showing value. CS also points out that the market is ascribing little value to the company's upcoming move into the Home Improvement space, where it will take the all-conquering Bunnings head on. While the market is clearly sceptical, Citi believes the move will prove a positive one.

Citi (Buy) values Woolies on a 15.3x forward PE, suggesting a shift up in market sentiment as the sales growth trend gains momentum. UBS (Buy) agrees that Woolies is undervalued while RBS (Buy) suggests Woolies offers better value than Wesfarmers given so much high expectation of Coles success is already baked into that price and higher multiple.

The stick in the mud is Macquarie (Underperform). It is fair to say that Macquarie has never been much of a Woolies fan, constantly fighting what it saw as overvaluation pre-GFC. The Macquarie analysts have long argued that trying to ascertain a supermarket's price/volume mix and success from quarterly sales numbers is fraught with the opportunity for misinterpretation. On that basis, Macquarie likes to keep it simple, and nothing is more simple than profit.

The Woolies March quarter sales result might have been a good one, but Macquarie points out that that management did not see fit to raise its FY11 profit guidance. The analysts believe the supermarket has not worked hard enough in extracting value and that a new strategy to deal with competition is needed. Perhaps the new CEO is the man for the job, but we will have to wait and see. Without any excitement from management over increasing profitability, Macquarie can't get excited either.

Notably, there was no change to the consensus price target to speak of emanating from this sales result. The earlier target of $29.44 has become $29.45. The Buy/Hold/Sell ratio in the FNArena data base stands at 5/1/2 with two brokers yet to make their reports.

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