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Investors checking out of Woolworths recovery story

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The glow from Woolworths’ strong sales performance through the start of the year has worn off in less than a day as concerns mount about margins and the continued struggles at discount chain Big W.

The supermarket chain released a third quarter update to the market on Tuesday revealing a barnstorming 5.1 per cent increase in sales, sparking a rally in its share price.

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Woolworths reports strong sales growth

Woolworths announces a strong growth in supermarket sales, with like-for-like sales rising 4.5 per cent in the March quarter.

But investors wiped out those gains on Wednesday, the stock closing down 2.71 per cent at $26.61.

Macquarie analysts on Wednesday morning reacted to the update by downgrading the stock to underperform and flagged concerns about margins as the central reason notwithstanding the “impressive” sales performance.

In a note to clients they said the current share price took account of an “aspirational earnings recovery in Australian food that we continue to view as unlikely in an increasingly competitive environment”.

Morgan Stanley analysts Thomas Kierath and Monique Rooney were also among those voicing scepticism.

“As the Woolworths sales-led recovery continues to gain momentum we remind investors of the difficult sales vs margin balancing act,” they said in a note to clients.

“While we see little risk for near-term earnings disappointment, we feel WOW’s rich valuation reflects too steep an earnings recovery.”

Woolworths chief executive Brad Banducci will need to convince investors on Big W's value. Woolworths chief executive Brad Banducci will need to convince investors on Big W’s value. Photo: Louie Douvis

They noted that Woolworths has struggled for the the past five years or so to balance sales growth and margins.

“Historically, too high focus on margins allowed competitors to take share, which weakened WOW’s competitive position and earnings power,” they said.

The analysts said they felt there was too much optimism about Woolworths’ ability to boost margins.

There were also doubts about how Woolworths would maintain its sales growth once its much-vaunted $1 billion investment in prices wound off.

At UBS analysts Nik Burns, Joseph Wong and Bethel Loh were more optimistic, telling clients that Woolworths was showing an “increasingly rational” approach to its cut-throat war on prices with Coles.

“We believe the turnaround at Woolworths is under way, but there still remains a long way to go,” they said.

There is a stronger consensus on struggling discount retailer Big W.

Morgan Stanley’s analysts noted that losses at the chain were now expected to be as much as $135 million for the half year to June 30.  

“It again leads us to question whether this business is actually a liability given the significant long dated lease liabilities,” they said.

“We suspect that it has little strategy interest to other parties,especially given news of Amazon entering the Australian market,and management seems to lack confidence in swift improvement.

“Big W and its long leases could prove to be an earnings drag and management distraction.”

​Macquarie branded Big W as “the biggest loser”.

They pointed out that the weak comparable sales results – a 5.7 per cent fall – was “not disastrous” compared to peers such as Target which fell 16 per cent over the quarter.

“But this is the eighth consecutive negative third quarter comparable [sales result] in a row. both Big W and Target need to validate their economic viability over the next twelve months.”

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