The next big event for ASX investors is the upcoming August reporting season and we may be in for a rough ride as I believe some of our best loved blue-chip stocks could disappoint on the earnings front.
One such candidate is Woolworths Group Ltd (ASX: WOW) with Citigroup warning that industry margins could come under pressure and that this risk is not reflected in current share prices.
The Woolworths' share price has jumped a little over 10% over the past year compared to the 7.2% gain by the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.
Too much good news in the Woolworths share price?
Woolies is the best performing supermarket stock as Metcash Limited (ASX: MTS) tumbled 2% into the red (it was as much as 20% higher before its weak profit results on Monday) and a similar fall by the Coles Group Ltd (ASX: COL) share price over the same period.
The Metcash experience shows how big a beating a high-flying stock can cop if it fails to live up to expectations, and that makes Woolies particularly vulnerable in my view.
Citi is also taking a cautious stand on Woolworths and it has a "sell" recommendation on the stock with a 12-month price target of $28.75 per share.
"Coles and Woolworths have both indicated at industry forums they expect growth of at least 3% for the sector. This is modest and raises the question about whether comparable store sales growth will be higher than comparable store cost growth," said Citi.
"Given Aldi, Costco and Kaufland combined may absorb 1.1% of growth and new store space absorbs another 0.6%, at the midpoint of the range, Woolworths and Coles will be left fighting for 1.8% LFL [like-for-like] sales growth including online."
Online growth a double-edged sword
Both Woolworths and Coles are investing big in their online business but if you were hoping that online growth would offset the softer growth of in-store sales, you might be disappointed.
"We think online grocery penetration rises from 2.1% in FY18 to 5% by FY25e, a CAGR of 19% growth. The problem for the chains is that Coles and Woolworths may only grow LFL sales less than 1% if industry growth is 3%," added the broker.
"Not only are online sales dilutive to margins, but store profits may fall because storebased sales growth is running below underlying store-based cost growth."
Woolworths more vulnerable to bad news
As you can probably tell, Citi isn't a big fan of the sector. It has a "sell" rating on Metcash and a "neutral" call on Coles.
I too share the broker's concern and I am more wary of Woolworths due to its market premium with the stock trading on a FY20 consensus price-earnings multiple of 24 times. That in itself isn't obscenely high but it does leave Woolworths very vulnerable if it can't deliver to market expectations.
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