Conventional share market wisdom has for decades maintained that big name blue chips are the best defensive plays when storm clouds begin to gather on the horizon.  By most accounts, Australia has weathered the GFC better than any other economy on the planet, with the exception of our principal benefactor, China.

Woolworth’s (WOW) is Australia’ largest retailer and a blue chip by any measure yet its defensive qualities in the recent economic turmoil have been unimpressive, to say the least.  Here is a one year share price movement for WOW:

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In truth, Woolworths is not the only Australian blue chip share failing to provide defensive cover in the short term.  In actuality, it contributed to its own share price decline when in January of 2011 it cut its forecast for retail sales in the coming year.  On 20 July, 2011, Woolworth CEO Michael Luscombe in a conference call to investors said he saw little hard evidence to expect a change in the now weakened consumer spending throughout Australia in the near future.

Considering the dismal share price performance, why should any investor look to WOW as a port in the storm?  The answer has to do with what can sometimes be a vast divergence between company fundamentals and share market valuation.  In reality, in tough times the valuation ratios we all love do not always serve us very well.  Why not?

The theory is the share price reflects market participants’ willingness to pay for a company’s current and anticipated fundamentals.  But when entire markets start trading on scant headlines and macroeconomic panic, fundamentals are no longer a part of the investing equation, in the short term.  As you know, eventually markets always return to trading on fundamentals and that is why blue chips like WOW and BHP can still be appealing investment prospects, even in the face of declining share price.  

Here then are five solid reasons to consider investing in WOW:

1.    Comp Sales

2.    Competitive Position

3.    Multiple Earnings Streams

4.    Management Changes

5.    Brand Identification

Comp Sales

Despite indicators showing declining consumer confidence and declining consumer spending to match, WOW managed to post positive same store comparative sales in the 4th quarter – 3% increase – and a 6% increase overall.  The food and liquor division for the full year, 2010, showed an overall increase of 4.3% with comparable store sales increasing 3%.

These are impressive numbers considering the state of the retailing sector overall.  If you follow the Top Ten Shorted Stocks list on TheBull, you know 7 of the top ten are retail shares, but WOW is not one of them.

Competitive Position

Wesfarmers and Woolworths are engaged in a battle for the Australian consumer and some recent news announcements highlight superior performance of Wesfarmers on key measures.  For example, the food & liquor division of Wesfarmers – Coles – showed a 6.7% increase in sales, topping WOW’s increase of 4.3%.  

However, both companies have multiple income streams so a more valid comparison should reflect the entire company, not just food & liquor.  Let’s start with a ten year table for WOW, showing revenue, dividends per share, and earnings per share.

WOW
10 Year Financials 
06/01
$
06/02
$
06/03
$
06/04
$
06/05
$
06/06
$
06/07
$
06/08
$$
06/09
$
06/10
$
EPS
(Earnings Per Share)
.402 .493 .572 .666 .754 .903 1.08 1.34 1.49 1.63
DPS
(Dividends Per Share)
.27 .33 .39 .45 .51 .59 .74 .92 1.04 1.15
Sales 20.08b 23.56b 25.18b 27.6b 30.47b 33.72b 35.51b 38.82b 40.56b 41.96b

 

Note that for each metric Woolworth’s performance has increased every year.  Of greater importance, note revenue, dividend, and earnings, all increased during the initial stages of the GFC and have continued to do so.  The table does not include results released in 2011 for FY 2010.

Now let’s look at Wesfarmers.  Wesfarmers did not acquire Coles Supermarkets until late 2007 so we have limited our table to five years.  Here are the numbers:

WES
5 Year Financials 
06/06
$
06/07
$
06/08
$
06/09
$
06/10
$
EPS
(Earnings Per Share)
2.162 1.92 1.704 1.706 1.35
DPS
(Dividends Per Share) 
1.99 2.08 1.89 1.10 1.25
Sales 21.92b 23.9b 54.27b 52.86b 44.74b

 

First, note the substantial drop in revenue between 2009 and 2010 and the accompanying drop in earnings per share.  Dividends per share did increase slightly.

Woolworths has a steady track record of improvement over a substantial period of time.  As always, the concern is the future, not the past.  So the question becomes can Woolworths continue to perform?

Multiple Earnings Streams

Although firmly ensconced in the retail sectors, Woolworths has multiple income streams within that sector that should allow the company overall to continue to perform.  In the worst of times, people have to eat and have a cocktail now and then, so coupled with Woolworth’s discounting business model, this earnings stream should hold up reasonably well no matter what happens.

Woolworths also operates discount department stores, consumer electronics outlets, as well as home improvement and hardware outlets.  

Management Changes

Woolworth’s CEO is retiring in September and many investors were surprised when the head of the company’s lucrative food and liquor division was passed over for the top job and subsequently resigned.  The new CEO is “shaking things up,” with his appointments, according to Australian news sites.  The company is doing an outside search for a replacement for the food and liquor division.

Management changes tend to rattle investors, but not all change is negative.  Considering the fact that competitor Wesfarmers’ Coles Supermarkets has been outperforming Woolworth’s food and liquor division for quite some time, a more surprising outcome might have been the ascension of an executive who had yet to figure out how to beat Coles.

Shortly after these management changes were announced, Deutsche Bank reiterated its buy rating on WOW with a price target of $31.

Brand Identification

Of all the reasons to consider investing in Woolworths right now, perhaps the most salient is brand identification.  The Brand Finance Institute recently announced recognition of Woolworths as Australia’s most valuable brand for 2011.

What is especially notable about this achievement is that the Brand Finance Institute includes financial performance in its evaluation.  Woolworths has already survived one Great Financial Crisis and there is no reason to believe they could not survive another.

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