Investors in Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) have not enjoyed 2015 thus far. That's because the share prices of two of the most prominent retailers in Australia have fallen by 10% and 1% respectively, with both stocks lagging behind the 3% gain of the ASX.
Of course, the reasons for their underperformance are fairly obvious: an uncertain macroeconomic outlook, a greater focus on price by consumers that is putting pressure on margins, as well as greater competition within the sector, with the likes of Aldi and Costco muscling in on the incumbents' market share. As such, the outlook for both Woolworths and Wesfarmers remains challenging.
Income Potential
However, the two companies still have considerable appeal and one reason for this is their excellent income potential. Both offer higher yields than the ASX, with Woolworths having a yield of 5% versus 4.6% for Wesfarmers and 4.3% for the ASX. Furthermore, they are both very reliable when it comes to increasing dividends, with their track records providing their investors with a degree of confidence regarding the potential for future dividend growth. For example, in the last five years Wesfarmers has increased dividends per share by 12.5% per annum, while in the last ten years Woolworths has boosted shareholder payouts at an annualised rate of 11.6%.
Valuations
There is more to the two companies than just impressive dividend prospects, though. For example, both of them appear to offer excellent value for money based on a highly relevant metric for retail companies; the price to sales (P/S) ratio. While the ASX has a P/S ratio of 1.61, Wesfarmers' P/S ratio is less than half that number at 0.8, while Woolworths' is even lower at just 0.56. As such, there is scope for upward reratings, although greater potential on a relative basis for Woolworths.
Future Prospects
Clearly, the supermarket sector is enduring a challenging period and, as such, Woolworths is forecast to post a decline in earnings of over 3% during the next two years. While disappointing, this is perhaps to be expected given the macroeconomic outlook. However, at least partly due to its increased diversity, stronger brands and conglomerate structure, Wesfarmers is set to weather the difficult trading conditions much better than its peer, with bottom line growth of 19.3% expected over the next two years.
Looking Ahead
While the outlook for the supermarket sector is somewhat pessimistic, Wesfarmers' forecast growth rate shows that, partly due to its conglomerate structure, it should still be able to post an encouraging level of growth. As such, it remains an appealing buy – especially while it has a relatively low valuation and high yield.
However, due to its super-low valuation, 5% yield, and excellent track record of growing shareholder payouts over a long period, Woolworths seems to be the better buy at the present time. Certainly, it comes with greater risk and evidence of this can be seen in its disappointing earnings outlook. However, while there is greater risk than investing in Wesfarmers, there may also be greater reward and, for investors who can live with a degree of volatility and uncertainty, Woolworths seems to be the more favourable long term investment at the present time.
