By Paul Rickard

It looks like the market wants to declare Woolies the winner in the supermarket wars, judging by the reaction to Wesfarmers first quarter retail sales results released yesterday. In a down day for stocks, Wesfarmers got hammered, losing 5.71% to $41.45, while Woolworths shed 0.52% to $25.12.

Coles has beaten Woolworths in the supermarket sales wars for the last 28 consecutive quarters. Yesterday’s first quarter sales result showed that on a same store basis, Coles grew food sales by 1.7% compared to the corresponding quarter in 2016. Worryingly for Wesfarmers, the rate of growth has fallen from 4.5% in the third quarter of 2016 to 3.2% in the fourth quarter and now down to just 1.7%.

Woolworths will report its first quarter sales tomorrow. Back in August, Woolworths said that comparable store food sales increased by 0.3% for the first eight weeks of the quarter to 21 August. This probably means a result for the quarter of just under 1%, so Coles will still collect a 29th victory, but the gap has clearly narrowed. One small upside for Coles is that price deflation eased to just 1.0% in the quarter. 

Same stores sales growth

The rate of sales growth also slowed in Wesfarmers “high performing” retail divisions. On a comparable stores basis, Kmart sales were up by 8.2%, while Bunnings and the home improvement business were up by 5.5%. The troublesome Target division, which is part way through a transition to an EDLP (everyday low price) format, had a horrible quarter with sales down by 21.9% on the corresponding quarter in FY16.

Wesfarmers also updated the market on production at its Bengalla and Curragh coal mines. The problem child in the Wesfarmers conglomerate, first-half EBIT for the resources division, is now expected to “broadly breakeven”. While this is an improvement on the first-half loss in 2016 of $122m for the resources division, the market was clearly hoping for a much improved result given the recent strong rise in metallurgical coal prices.

So, while some of yesterday’s reaction was disappointment with the resources division guidance, the market was underwhelmed by the sales results for Wesfarmers retail businesses.

Positive returns on market for both Wesfarmers and Woolworths

Despite yesterday’s sell-off, both stocks show positive returns this year. Woolworths has now crept ahead, with a return of 5.7%, compared to Wesfarmers 4.1%. This points to the market starting to bet on the Woolworths recovery story.

Interestingly, short positions in Woolworths are being closed. While they are still at an extraordinarily high level for an ASX 20 company with 86.3m shares or 6.7% of the total issued capital sold short, this is down on the peak of 8.5% a few months back. By comparison, only 1.26% of Wesfarmers shares are short sold.

If you consider the price action, the market looks like it now prefers Wesfarmers. But is it too early to declare victory for Woolworths?

The brokers

The brokers have a different view. While they are not positive about either stock, they are more negative on Woolworths than Wesfarmers. As the following table shows, they are, as a group, quite negative on Woolworths. The consensus target price is $21.06, some 16.2% below yesterday’s closing price. 

Broker Recommendations and Target Prices*

Over the next few days, there will be some changes to these recommendations as the brokers digest the quarterly sales results. However, it is unlikely that there will be major changes to earnings forecasts, so target prices shouldn’t change too much.

On a forecast basis, the brokers have Wesfarmers trading on a multiple of 16.9 times FY17 earnings and 15.9 times FY18 earnings. The forecast dividend yield is a relatively attractive 4.9% for FY17 and 5.2% in FY18. Woolworths, on the other hand, is trading on a multiple of 22.0 times forecast FY17 earnings and 20.8 times FY18 earnings. The dividend yield is 3.2%.

My view

Unless Woolworths comes out with a really upbeat sales result tomorrow, Wesfarmers remains my preferred pick in this sector. Sure, Woolworths is potentially a recovery story, but it really hasn’t demonstrated that much yet. And can it really substantiate a multiple of 22 times when Wesfarmers is on a multiple of 17 times?

My hunch is that when the market digests these results over the next couple of days, the multiple gap will narrow. While Coles and Woolies are getting closer, the market has already priced this in.

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