Woolworths to double free cash flow by 2020: BAML

As the market takes a shine to Woolworths, a BAML analyst says the retailer can lift its free cash flow to $2.5bn by 2020.

People shop at a Woolworths store in Sydney. (AFP PHOTO/PETER PARKS)

Woolworths will double free cash flow by 2020 if it executes its supermarket strategy well, justifying a $40 a share price target according to Bank of America Merrill Lynch analyst David Errington.

In a note published today, BAML is tipping free cash flow at the retailer to grow from $1.2 billion this year to $2.5bn in 2020.

Errington argues supermarkets have the luxury of selling stock before they have to pay for it, so, if they can factor growth into the equation, then free cash flow yield will increase faster.

Errington was the first analyst in the market to put a buy on Woolworths (WOW) when Gordon Cairns took over as chair in August 2015 promising to shut down the loss making Masters hardware store.

That happened late last year.

The hardware store drained cash because Woolworths had to pay for its merchandise when it left the docks in Shanghai then sold it at a loss 60 days later.

BAML is tipping earnings per share growth from $1.44 this year to $1.64 in 2018 and $1.73 a share in 2019.

But it’s the faster cash generation which has BAML excited about the stock.

Other analysts have now joined the Woolworths bandwagon, with Deutsche Bank’s Michael Simotas following BAML’s lead and placing a buy on the stock in December — 16 months after Errington.

JP Morgan followed last week and UBS this week.

Morgan Stanley and Credit Suisse are still negative on the stock.

Later this month, Woolworths is expected to top Coles in same store sales growth for the first time in seven years.

But this is after spending $1bn in price cuts and its sales growth compares with three consecutive negative quarters last year, against Coles’ growth of 4.6 per cent in the second quarter last year.