By Paul Rickard

Right up there, if not number one on the list of the “top 10” questions asked by investors is the question - is Woolworths a buy yet? Not surprising really, given that Woolworths continues to underperform.

In 2016, Woolworths has fallen from $24.50 to yesterday’s close of $21.26, paid a dividend of 44c, for a return of -11.4%. This compares to Wesfarmers return (including dividend) of +3.7% over the same period, or the broader market’s -0.7%. And the announcement of a new CEO hasn’t done anything for the share price. Since the close of business on 25 February, Woolworths has underperformed relative to Wesfarmers, returning -0.9% compared to Wesfarmers +6.9%.

So, is Woolworths a buy yet?

While Woolworths has made strategic progress with the appointment of CEO Brad Banducci and an exit plan for the Masters home improvement business, it still faces two major challenges - fixing Big W, and loss of market share/crunching margin in its supermarket business. Problems with the former could be behind it if new Big W CEO Sally Macdonald has been able to wave her magic wand. However, there is no data available yet to support this assertion, and given that Big W was such a mess (see sales performance relative to Kmart below), this remains an open issue.

The real problem of course is the supermarkets business, where Woolworths is losing share to rivals such as Coles and Aldi, and a price war is crunching margins. As Australian food and liquor represents around 70% of group sales for Woolworths and a little more in group EBIT, any problem here greatly outweighs the challenges with the Big W or Masters businesses.

Last week, Wesfarmers released its third quarter sales results. Coles continued to make headway, growing its sales on a comparable store basis by 4.4% compared to the corresponding quarter in 2015. With Aldi expected to be increasing market share, this bodes badly for Woolworths, which faces its 27th consecutive quarterly loss to Coles in the sales wars. Woolworths reports its third quarter sales results next Tuesday - a flat to marginally negative outcome for quarterly sales growth (Easter adjusted) is on the cards.

Comparable store sales

* Adjusted for Easter - source Company Reports

The other piece of news in the Wesfarmers’ result was an estimate of price deflation in supermarket goods for the quarter of 2.0% compared to the corresponding quarter in 2015. Price deflation is caused by falling commodity prices finding their way into producer prices, offset by a weaker Australian dollar and change in the export mix, and of course, price competition by the supermarkets. The worrying aspect is that deflation is potentially accelerating - 2.0% in the March Quarter was up on the December quarter of 1.0%.

Matching this is anecdotal data that says that the supermarket price wars are getting more intense. Woolworths, which has the highest gross margin, has the most to lose. Woolworths has said that it is cutting prices (read margin) to maintain share, but so far, there is no sign that its sales and service strategy is winning. Until the quarterly sales numbers start to improve and Woolworths makes up ground against arch competitor Coles, my sense is that Woolworths share price is going to remain in the doldrums.

What do the brokers say? 

The brokers remain reasonably downbeat on Woolworths. Sentiment is -0.5 (scale -1.0 is most negative to +1.0 most positive), with the consensus target price at $21.36. The range on the latter is $26.13 from Credit Suisse (the highest) through to the most bearish at $17.00 from Morgan Stanley.

Source: FN Arena, as at 27 April 2016

Woolworths is trading on a multiple of 19.5 times forecast FY 16 earnings, and 16.1 times FY 17 earnings.

Another guide to professional market sentiment is the short sold positions. While the position in Woolworths has come down a little in recent weeks, it is still by far and away the largest of any top 20 company in Australia. According to the latest figures from ASIC, 105.1m Woolworths shares worth approximately $2.2bn are sold short, or 8.22% of the ordinary shares on issue. This compares to Wesfarmers, where 28.1m shares or 2.50% are sold short. 

Bottom line

I don’t think an imminent recovery in the supermarket business is likely. We might be pleasantly surprised next Tuesday when Woolworths updates the market on its 3rd quarter, but the odds are against this.

While there may be some “big figure” support if Woolworths’ shares test the $20 mark, I don’t see anything particularly magic in this number. At price multiples in the high teens, Woolworths is no bargain stock. When there are signs that Woolworths has momentum in the business, that’s the time to buy. Until then be patient - other stocks will provide a better risk adjusted return.