I have never liked Woolworths, with its weak brand, unfocused retail format, and uncertain wholesale business. Now, at a time when things could not look worse, I am changing my mind.

My main reason for optimism is that the largest shareholder is expresing dissatisfaction with the management, which makes it likely that things will change.

It is often useful for investors to ask themselves whether, if they had that kind of money, they would buy the company outright. In the case of Woolworths I would say the answer is yes. On and EV/sales of 0.3× (at 30.75p) and a gross margin that, although it deteriorated a full percentage point, remains reasonable at 25%, this looks like a business that can recover.

The key is to turn around the loss making retail business. It is not difficult to think of strategies that stand a good chance of succeeding:

• Buy a small retailer with overlapping product lines and a format that has been successful, and roll out the better format across the business.
• Keep trying new, internally developed formats.
• Sell stores and shrink the business.
• Break up the group. It should be possible to find trade buyers for both the retail and wholesale businesses.

Of course, the risk is that Woolworths will continue as it is. The problems as:

• It is expensive on a historic PE of 25×.
• The retail business is loss making and badly positioned.
• The wholesale business is is uncertain: it lost a major customer (Tesco) in the course of the year.
• The company has been buying growth through acquisitions.
• The wholesale business is seeing an organic decline (offset by acquisitions) and the retail business a like-for-like decline.
• The management appears to have no convincing new strategy.

Edit: 14th April 2007. I also think the company is a potential takeover target for someone who wants to put in new management and turn it around, or who can integrate it with an existing format. This is, of course, a very speculative bull argument.