Question

A friend of yours is interested to invest in a listed South African company in the fashion and retail industry. Specifically, two companies have caught his attention and he has asked you to gather some financial information on the two companies and guide him to make his investment decision. The two companies under consideration are Woolworths and Mr Price (both are large retailers with a focus on fashion and home ware – even though Woolworths also offers food; but for the purposes of this analysis, assume that these two companies are relatively similar and can be compared with one another).Is your friend correct in assuming that Woolworths is undervalued relative to Mr Price given the information above alone? Explain why you agree or disagree with his statement and what else should we may require to consider in order to draw a better conclusion?

	Price (rand)	EPS (rand)	Current P/E
Mr Price	185.05	9.11	20.3
Woolworths	60.13	4.2	14.29
Net turnover growth	2013	2014	2015	2016	Artihmetic mean growth
Mr Price	12.74%	19.32%	13.78%	10.62%	14.12%
Woolworths	23.15%	12.72%	42.31%	15.04%	23.31%
Cash flow per share	2013	2014	2015	2016
Mr Price	797.58	944.47	1099.13	1191.97
Woolworths	483.53	573.37	612.05	657.75

Answer 1

I dont think Woolsworth is undervalued compared to Mr Price based on the limited details given above. The friend might have said that Woolsworth is undervalued by only looking low P/E ratio of Woolsworth and its turnover growth. Low P/E generally implies undervaluing of a company.

But a company's value in equity market is mainly influenced by the existing healthy and future cashflows it can offer. If we look in that perspective, we can see that Woolsworth Cashflow/share is only 657 whereas Mr Price has 1191.97; Mr Price also has the cashflow cagr growth at 14.3% whereas Woolsworth has 10.7%.

Based on these parameter the market is not undervaluing Woolsworth . Hence the difference of both the companies are justified.