The Woolworths Group Ltd (ASX: WOW) stock price has risen 12% since early May from its 52-week low of $30.49 to $34.17 as of Friday's close. However, as the chart below shows, it is still down more than 11% over the past year.
Investors may be wondering whether this is an opportunity or if it has risen as far as it can go for the foreseeable future.
Firstly, we shouldn't anchor to an old share price – just because the Woolworths share price was $40 just over a year ago doesn't mean it has a right to recover to that level any time soon.
Woolworths' stock price is lower for a variety of possible reasons, but I'd attribute some of that to weak sales growth, including lessening inflation. While reducing inflation is a good thing for households, it means Woolworths has lost the tailwind for its sales.
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Is the Woolworths stock price now fair value?
In the third quarter of FY24, Woolworths reported that its Australian food sales increased just 1.5% to $12.6 billion, while total third-quarter group sales increased 2.8% to $16.8 billion.
The broker UBS said its core Australian food sales were weak, causing the broker to reduce its estimate for Woolworths' earnings per share (EPS) by 6.9% and 8.5% due to a few factors. UBS referred to lower Australian food and Big W earnings before interest and tax (EBIT), as well as lower dividends from Endeavour Group Ltd (ASX: EDV) after Woolworths sold shares. Meanwhile, UBS increased its estimate for New Zealand food EBIT.
The broker has a neutral rating on Woolworths stock because of the weakness in the food sales and a potential for further slowing at Big W.
A price target tells investors where the broker thinks Woolworths shares will be in 12 months. UBS has a price target of $32.50 on Woolworths shares, which is currently around 5% lower than its current level.
UBS forecasts that Woolworths could generate EPS of $1.32 in both FY24 and FY25, putting the current valuation at 26x forward earnings.
What could send the company higher?
Interest rate cuts could certainly help support the Woolworths stock price if and when they come. Investors may be more willing to pay a higher price for Woolworths' earnings if safer investments (like bonds) don't yield as much.
Warren Buffett, one of the world's greatest investors, once described why interest rates are so important:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
Over the long term, if the ASX share can grow its earnings, then that could lead to an increase in the Woolworths share price over time.
The broker UBS thinks Woolworths' EPS could increase by 7.6% in FY26, 10.6% in FY27, and 10.8% in FY28. That's not exactly rocketing growth, but I think it can help push up Woolworths shares over time if its profit keeps growing. The market usually judges a business by how much profit it's making.
