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Woolworths shares more likely to fall than rise: UBS

Tuesday, 26 Jul 2016 09:32:20 | Michael Janda

Woolworths still has some of the highest supermarket profit margins globally. (ABC News: Nic MacBean)

Woolworths may have taken decisive action to stem the bleeding in its core supermarkets division, but UBS still sees more risks than upside.

In a note released after Woolworths yesterday unveiled a near-billion-dollar plan to cut 500 staff and close at least 30 underperforming stores, UBS retail analysts said the supermarket giant still faces a very challenging market.

Aside from Woolworths' own problems, after taking its eye off the supermarket division during its failed Masters hardware experiment, UBS is forecasting that the Australian supermarket sector will become even more competitive.

While the investment banking giant has a relatively rosy view of the retail outlook, and is expecting supermarket sales to rise 3.4 per cent over the next year, it is not necessarily expecting Woolworths to benefit.

While we continue to see risk to Australian grocery forecasts, there are some signs emerging that trading is no longer deteriorating and may have bottomed.

"That said, we continue to believe that achieving solid positive like-for-like growth will be a challenge for Woolworths in financial year 2017."

Four key challenges for Woolies growth

There are four key reasons why UBS sees the supermarket giant struggling to grow sales:

  1. Slowing market growth;
  2. Market discounting;
  3. Aldi's entry into SA and WA; and
  4. Weak staff morale.

The biggest threat to Woolworths, and its currently ascendant rival Coles, is the growth of cut-price supermarkets such as Aldi, and the potential entry of other large international rivals, such as fellow German retailer Lidl.

The reason these entrants are particularly dangerous is not just their potential to take significant market share - Aldi already has more than 10 per cent - but the huge pressure on margins these low-cost, home brand-focused retailers generate.

As UBS highlighted, Woolworths still has profit margins greater than 5 per cent in food and liquor, more than two-and-a-half times what UK supermarkets generate and nearly double the European average.

UBS data show Australian supermarket profit margins are still high globally. Photo: UBS data show Australian supermarket profit margins are still high globally. (UBS)

These are markets where Aldi and Lidl have been operating for a long time, so it is reasonable to assume there will be further margin pressure and grocery price cuts in Australia.

On the UBS base-case scenario, current supermarket trends continue, and Woolworths should be worth less than $20 a share (versus today's level of $23.48 at 10:48am AEST).

UBS has a sell rating on Woolworths, which is lower than some other analysts, such as Deutsche Bank which has a hold rating and a price target that increased from $21.50 to $23 after yesterday's announcement.

On an upside scenario, UBS said an unlikely return to a cosy duopoly in Australian supermarkets would see Woolworths worth almost $36 a share.

However, if there is a genuine supermarket price war that cuts into Australia's world-leading margins, UBS said Woolworths could fall to just $8.60 a share.

The analysts warn that risk to the current share price is skewed 1 to 1.4 to the downside.

UBS upside and downside forecasts for Woolworths share price Photo: UBS says there is much more downside than upside to Woolworths' current share price. (UBS)

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