Woolies Woes Not Over Yet

Woolworths (ASX: WOW) has had a painful few years. Loyal shareholders watched on as the company’s share price almost halved – from above $38 in 2014 to a low just above $20 last July. It’s hovered in the mid $20s since then.

Failure of its Masters home improvement stores, was the major disaster to contend with, and multiple changes to company management didn’t help reassure investors either.

The struggling Big W division also weighed on performance. And WOW got into a nasty – and well-publicised – price war with Wesfarmers-owned Coles. Cutting prices was taken to extremes as each tried to pull in customers with bargain prices to hold onto their market share.

Yet there has been of talk the last few weeks that maybe its fortunes are changing.

Woolworths is making improvements. It left the Masters debacle behind in December, implemented a new division head for Big W, while the price war seems to have cooled off. Both WOW and Coles realised that lower prices mean lower profit margins and they were just hurting themselves in the end.

The big news making the papers was that Woolworths ‘wins’ Christmas.

A UBS survey of supermarket industry suppliers found that Woolies fared better than Coles over the festive season. The broker said that while Coles still leads the market in almost all categories, it is ‘ceding some of its lead to Woolworths’.

Morgan Stanley had a similar opinion, expecting WOW’s food and liquor sales to have fared better than Coles in the December quarter. If results come in as expected on February 24 it would be the first time WOW had bettered Coles since 2009.

Despite the assumed improved quarter Morgan Stanley, still has an ‘Underweight’ target on the stock. The broker says that sales numbers are likely to come at the expense of margins, which it expects to be ‘disappointing’ in 2017.

And Macquarie noted that WOW’s performance was improved this Christmas season, but that compares to a very poor performance a year earlier.

It should be noted that broker projections and price targets are only estimates and may not be met. Also, historical data in terms of earnings performance and/or share trading patterns should not be used as the basis for an investment as they may or may not be replicated. Those considering this stock should seek independent financial advice.

While the media has honed in on the relative performance of Woolworths versus Coles, this is just part of the story.

The overwhelming issue at hand is not whether Woolworths can come out ahead of Coles from one quarter to another, nor is it to do with the company’s past failed ventures.

New competition posing a threat to margins

The big factor is whether WOW, and Coles for that matter, are able to maintain their near-duopoly and world leading margins in the face of new competitors.

Prior to Woolies’ multitude of issues, summarised above, the retailer enjoyed the highest supermarket profit margins anywhere in the world. Coles too, long enjoyed margins well above that seen by supermarkets elsewhere in the world.

But as new competition came to Australia – attracted by the world leading margins – Woolworths’ (and Coles’) margins are sliding back to levels seen more competitive markets overseas.

The $94 billion Australian supermarket industry, and its world-leading profit margins, is facing a flood of new competition.

Since entering Australia in 2001, ALDI opened 270 stores and nabbed 12.5% of all supermarket shoppers. That’s up from just 5.5% ten years ago. While WOW still controls much more of the market, in that time its share price dropped by almost 6% to 36.3%.

The company has more stores planned, and with ALDI leading all Australian supermarkets on customer satisfaction signs are looking good for the discount German chain. But ALDI (and Coles) are old news.

Following ALDI’s success a second German-owned discount supermarket, Lidl, is believed to be gearing up to enter Australia. Last year Lidl registered trademarks in Australia across a range of its brands. Not much more is known yet, as it is rumoured to be keeping quiet so not to alert competitors to its arrival.

Another threat could come from Kogan, which launched its Pantry online grocery store more than a year ago. It’s gotten off to a fairly slow start, with limited products on offer, but it has potential as Kogan has proven itself a successful online retailer.

The big news came from Jeff Bezon, CEO of global behemoth retailer Amazon, who last year announced plans to expand the company’s presence in Australia. He suggested it could be here as early as this coming September.

The plan is to first open its Prime Now online stores, which provide free shipping on a range of products from groceries to electronics to hot meals. Then to launch Amazon Fresh. This involves small brick and mortar stores stocking fresh produce plus online stores with tens of thousands of products that can be home delivered or picked up through drive through windows.

Citi analysts say Amazon’s arrival would be a disruptive force on the local grocery market. It estimated that Amazon’s could generate sales of $3.5 billion to $4 billion within its first five years. This translates to around 14% of online retailing and 1.1% of all retail sales in Australia.

More competition is good news for shoppers, but it’s certainly a challenge for Woolworths and its shareholders.