Woolworths (ASX: WOW) and Wesfarmers (ASX: WES) are two of Australia's largest companies and also the owners of some of Australia's most recognisable brands. Both have enjoyed strong share price rises over the past year, but is one currently better value than the other?
Similarities and differences
Woolworths owns its namesake the supermarket chain, as well as discount retailer Big W, hardware start-up Masters, and liquor stores including Dan Murphy's, BWS and Cellarmasters.
Wesfarmers, meanwhile, not only owns Coles supermarkets but also Target, Kmart, Liquorland, Officeworks, Bunnings, a multitude of insurance operations, coal mining interests, industrial safety products and services and a suite of chemicals and fertiliser operations.
Wesfarmers' many interests outside of retailing make it not only a unique conglomerate of businesses but also a significantly more diversified firm than Woolworths. That being said, the size and market share between the supermarket divisions make comparison reasonable and necessary.
Valuation
The breadth of businesses housed in Wesfarmers arguably makes the company's growth potential greater. Currently this higher growth profile is reflected in both the higher multiple that Wesfarmers trades on and also in broker forecasts for earnings growth over the next year.
Consensus earnings per share (eps) for Wesfarmers are 199.8 cents per share (cps) in 2013, increasing to 223.2 cps in 2014, which equates to a growth rate of 11.7%.
Consensus forecasts for Woolworths' eps meanwhile, are for an increase from 188.5 cps in 2013 to 205.4 cps in 2014, which equates to growth of 9%.
Should these earnings estimates prove accurate, then based on the 2014 forecasts, at $39.58 Wesfarmers is trading on a price-to-earnings (PE) multiple of 17.7. While Woolworths, at a current share price of $33.06 is trading on a PE of 16.1.
So are these reasonable prices to pay?
Outside of comparing Wesfarmers to Woolworths there aren't many close comparisons to provide further relative valuation against. The other significant listed conglomerate is Washington H. Soul Pattison (ASX: SOL) and this firm is currently trading on a trailing PE of nearly 27 times given its heavy exposure to coal mining which have depressed earnings. While in the supermarket space, Metcash (ASX: MTS), which supplies IGA stores, is a wholesale distributor rather than a retailer, making its business model different and not really comparable to Coles and Woolies.
Foolish takeaway
With that lack of direct comparison, the market average is actually a pretty good barometer for Woolworths and Wesfarmers. Given their size and significant market share, they are unlikely to grow at rates much faster than the average. Having said that, given Wesfarmers' potential to diversify into completely new lines of business, its growth profile is higher although so are its risks.
The market average PE excluding financials is currently near 16 times and 14 times 2013 and 2014 earnings, respectively. Given the high quality, defensive nature of these two businesses it is reasonable that they both sell for a slight premium. However, given Wesfarmers' stronger growth potential, it could well be worth "paying up" for Wesfarmers over Woolworths.
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
