What Next for Woolworths?

Only a few years ago, the share price of supermarket giant, Woolworths Group Ltd [ASX:WOW] was locked into what seemed like a spiral dive.

Well on its way to hit $40 in 2014, by 2016 it was a very different story for the Woolworths share price. By then, Woolworths’ shares were struggling to stay above $20.

For one of the biggest and most widely held stocks on the ASX, it was a crushing blow. Not least for its multitude of shareholders who relied on Woolworths for its dividend.

Along with the halving of its share price, Woolworths’ investors copped another whammy. While the share price fell, so too did the size of Woolworths’ dividend.

There were a number of reasons for the fall in the Woolworths share price. At the time, Woolworths were locked in an intensive price war with arch-rival Coles Group [ASX:COL] — at the time a full subsidiary of Wesfarmers Ltd [ASX:WES].

Both companies cut prices to the wick in the battle for market share. In doing so, they cut a swathe through their margins — not to mention those of the companies who supplied goods to them.

Once a cosy oligopoly, the supermarket giants also had another battle on their hands. The nationwide roll out of the Aldi discount chain made a massive change to the structure of the market.

With its no frills, super-lean business model — a model it has replicated across its 11,000 stores worldwide — Aldi decimated the margins on some of the most popular products of the bigger supermarkets.

Products like milk, cereal, spreads, biscuits, frozen food, soft drinks, chips and lollies.

However, since its low point in mid-2016, the Woolworths share price has headed in just one direction…up.

Only last month (November 2019), the Woolworths share price finally traded through the elusive $40 mark, even if by just a couple of cents.

And having also bottomed out in 2016, Woolworths’ once prized dividend has slowly began to ratchet higher.

So what has brought about this turn of events?

For a start, Woolworths and Coles gave up on their senseless price war. After years of toing and froing, neither group had anything to show for it.

Woolworths also got to work further enhancing its fresh food business — a clear advantage it had over discount chain Aldi.

More progress has been had, as highlighted at Woolworths AGM on 16 December. Woolworths reported a massive 7.1% jump (from continuing operations) in group sales for the first quarter, compared to the same time last year.

Adding further momentum to the share price is more planned corporate activity. Woolworths are now in the process of spinning off its drinks and hospitality business into a new entity, Endeavour Group.

Endeavour will include Woolworths’ current holdings of pubs and hotel held via its ALH Group. It will also include Dan Murphy’s and BWS — two of the most well-known retail beverage chains.

With all this activity, and strong sales momentum, it is little wonder that the Woolworths share price has been on a tear.

But with a P/E ratio of 27 — compared to the market’s P/E of 18 — the Woolworths share price might just be getting ahead of itself. Especially if you compare it to international chains like Tesco, which trades on a P/E of 17.

And while the rising share price has been a boon to shareholders, Woolworths’ dividend might struggle to meet investors’ expectations.

With a current yield of just 2.7%, there are plenty of other stocks that pay a substantially better yield than that.

What investors need to be wary of is any change in sales momentum. A drop in sales growth, combined with any downturn in the market, could punish a stock trading on such a high P/E. It might also put pressure once again on Woolworths’ dividend.

All the best,

Matt Hibbard,

The Rum Rebellion

PS: While Woolworths’ recent strong price action has been a boon to investors, there are a multitude of other higher paying dividend stocks on the market. You can read about them by clicking here.

The Rum Rebellion