The Fundamental View
Woolworths is a key part of our model portfolio. While its FY13 results were at expectations, demonstrating a mature business operating in a ‘normal’ environment, equity investors haven’t been as gentle to its shares as we believe it deserves. Management guided 4-7% of earnings growth next year with no foreseeable macroeconomic obstacles. The company also outlined its investment guidance next year in the form of capital expenditure, noticing a marked shift from store roll outs to improvement in efficiencies. It seems the market is not happy with the lack of store openings. While an inward-looking investment program appears to signal of the end of strong external growth, there is a major difference in Woolworths’ business model from Coca-Cola Amatil, another example of a company engaged in inward-looking capital investment, which makes us believe it will be successful over the coming years. Unlike Woolworths, which has been operating in an environment of falling prices, CCA has been raising prices and volume simultaneously, on top of the cost efficiencies from its investments. This quest for high returns on capital backfired, snapping returns as customers have switched away from CCA’s product line.
Woolworths’ business model has long been to distribute its returns not just among shareholders, but also to customers in the form of price discounting. As Woolworths competes and customers benefit from lower prices, market share rises in its existing stores fuel further returns, as long as they are matched by reinvestment into cost efficiencies. This is precisely what is happening now. After Woolworths has expanded its store network across Australia, in the face of increased competition from Coles, it is deploying capital to reduce its cost of doing business, in order to protect its leading market share and ensure future returns to shareholders and customers. For this reason, we see Woolworths’ returns as sustainable into the future.
Another talking point for investors, especially those who are bears on Woolworths, seems to be the lack of traction of Masters, Woolworths homemaker brand, which is being rolled out across Australia. Reporting a loss of $138.9 million in FY13, worse than expected, management intend on breaking even by FY16 as the store network ‘scales up’ and generates efficiencies that come with a large geographic footprint. In Woolworths first quarter update, Masters sales increased 52.9% on the previous year, with higher sales per square metre, a key measure of store efficiency. 34 stores were open at the end of September.
The Chart View
WOW appears to have finished pulling back. When you zoom into a 3 wave pullback, it will often have a smaller wave structure within it. It can either be 3-3-3 or 3-3-5. In this case, our larger 3 wave pullback is labelled a-b-c, and the smaller wave structure within it appears to be a 3-3-5. This is indicated by the coloured arrows. It has also led WOW to be oversold on the RSI (indicated by the blue circle). It is not often that WOW gets oversold, but when it does, it tends to rally, just like in June this year. So we are confident that the pullback in WOW is finally complete and it should attempt a rally up towards $37 to retest the April high.