Woolworths shares in $1bn pullback

The retailer has pared yesterday’s market gains as analysts conclude the run-up is not yet justified.

UBS warned the turnaround could extend beyond management’s three-to-five-year time frame. Picture: Brett Costello.

Woolworths has lost more than $1 billion of the $2.3bn rise in valuation it saw yesterday as analysts question the sustainability of its share price rally.

The embattled retailer has enjoyed a startling recovery in its market fortunes since striking a new 10-year low of $20.30 on June 6, lifting 20 per cent to $24.30 at the close of trade on Monday.

The rerating by the market reached a climax yesterday as the group’s shares rose 8 per cent, their biggest one-day incline for almost two decades on the back of its restructuring announcement.

But analysts are dubious on the euphoria, with none of the four major investment banks to release notes this morning deciding to raise their target price.

The most optimistic of the lot — Credit Suisse analyst Grant Saligari — even opted to reduce his view on the retailer from ‘outperform’ to ‘neutral’ in a sign of the scepticism that surrounds the current valuation.

Mr Saligari did, however, largely welcome the restructuring activity as “textbook”, but concluded progress was not yet sufficient to justify the run-up in the share price over recent weeks.

“We agree with the strategy, but don’t see the level of performance improvement needed to justify a valuation upgrade,” he said.

Despite lowering its recommendation, Credit Suisse retained a 12-month price target of $24.50 on the retailer.

The action came after Woolworths announced $959 million in impairments on Monday, along with 500 job cuts and a plan to slow the pace of grocery store expansion.

The group has detailed over $4bn in charges this year as it looks to revive its flagging fortunes in the face of heated competition from longtime rival Coles and recent arrival Aldi.

Investors cheered the update as it came alongside talk of improvement at its core grocery chain over the past two months.

Morgan Stanley’s Thomas Kierath — who maintained a street-low target price of $17 — agreed with Mr Saligari that the share price rally had gone too far, tipping a fall relative to the market ahead of its full-year results announcement on August 25.

“We believe the rally is unfounded given weak supermarket sales trends, ongoing restructuring and heightened fiscal 2017 earnings risk,” he said.

Mr Kierath also doubted the merit of any uptick in performance over June and July, which was seen as the primary catalyst for yesterday’s surge. In his view the improvement in volumes was expected given persistent deflation in the fresh food sector.

“[Woolworths] implied that volume growth had turned from negative to positive. We note, however, that under the company’s revised method for calculating Australian food and liquor inflation that was provided in the first quarter, the implied volume growth based on this method has in fact been positive since the fourth quarter of 2015,” he said.

“Therefore, we find it confusing that management emphasised this point during the conference call.

“And, moreover, did not discuss the fresh food-led fourth-quarter deflation that should have provided an uplift to volumes, even if it wasn’t enough to offset the deflation.”

UBS analyst Ben Gilbert was also cautious, maintaining the view Woolworths had the capacity to fix its problems, but warning the turnaround could extend beyond the three-to-five-year time frame detailed by management.

“In our view the turnaround will take longer and cost more than many expect,” he wrote in a note.

UBS maintains a ‘sell’ rating and price target of $19.30.

Meanwhile, analysts at Macquarie admitted the long history of Woolworths and its place as a market leader entitled it to a premium valuation once its turnaround showed signs of life, but believed the recent price action was too exuberant.

“There still remains significant uncertainty around Woolworths’ medium-term earnings profile and in our view the stock is factoring in a large degree of optimism based on the current share price,” the group said.

“While we accept that the multiple for Woolworths should head back to a premium to market once a recovery is taking place, we remain unconvinced that we have arrived at our destination.”

Macquarie has an ‘underperform’ rating and a reduced price target of $18.85, trimmed 4.2 per cent after the update from the company on Monday.

Macquarie also cautioned on a lack of “wiggle room” on its credit rating, although it appears the ratings agencies are willing to wait on more details on turnaround progress before making any rating calls.

Moody’s today said the latest impairments and restructuring charges would not have an immediate impact on ratings, although it did hint the growing rise of Aldi would afford Woolworths little latitude in maintaining its current debt rating.

At the 4.15pm (AEST) close of trade, Woolworths shares were down 3.3 per cent at $23.50 against a flat broader market.