Key Morningstar Metrics for Woolworths (ASX:WOW)

Data from Morningstar Direct as of 22 February 2024

What we think of Woolworths’ Shares

After the demerger of its liquor retailing and hospitality operations in 2021, Woolworths is essentially a pure-play food retailer. Woolworths has long been Australia's largest supermarket. While we think impressive market share gains of discounter Aldi have come to an end, we expect the competitive tension to intensify in the online channel, particularly between the Coles-Ocado partnership and Woolworths. Amazon Australia already sells pantry items and the launch of Amazon Fresh is probable in the coming years, but we expect Amazon to remain a marginal player in Australian food for the foreseeable future. Nevertheless, Woolworths is a strong business, with competitive advantages stemming from its leading market share, resulting in low cost of doing business, high bargaining power, and a vast store network. We expect these attributes to enable Woolworths to maintain its market share and protect operating margins.

Woolworths Share Price (ASX: WOW)

Source: Morningstar Direct. Data as of 22 February 2024

Woolworths Economic Moat Rating

We believe Woolworths has a narrow economic moat sourced from cost advantages underpinned by its significant scale. As of 2022, we estimate Woolworths to have 36% market share with roughly 25% more sales and stores than the second-largest supermarket in Australia, Coles, which commands 28% market share. In recent years, Woolworths has maintained an average EBIT margin of 5% in Australian food and about 50 basis points ahead of Coles, whilst also managing to expand market share. Woolworths’ growing market share and superior operating margin over Coles and other competitors is attributable to its narrow economic moat and also provides Woolworths with extra protection to defend its market dominance and the ability to outcompete on price cutting.

Woolworths’ dominant scale allows it to leverage distribution, administration, and marketing costs in a way that smaller competitors cannot. From this alone, we estimate Woolworths to have an operating margin advantage over its closest competitor. Aside from Coles, Woolworths also has superior bargaining power due to its higher sales volumes over its competitors, and is able to negotiate lower prices and better terms with its supplier. As a result of their combined 65% market share—which they have held steady despite Aldi’s growth—consumer packaged goods firms require both Woolworths and Coles as distribution channels to penetrate the Australian market comprehensively. A significant shift in their bargaining power is unlikely to occur over the next decade. As a fully integrated supermarket, Woolworths also has an additional cost advantage over independent retailers. This includes those within the IGA network—representing 11% of the Australian food retailing market—which only earn a retailing margin, with the wholesaler margin captured by others, like Metcash.

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Woolworths Risk and Uncertainty

Woolworths gains comfort from its market-leading operating margins in the core Australian supermarkets segment. However, several competitors could raise the competitive bar: Arch rival Coles supermarkets; number three discount supermarket chain Aldi; Wesfarmers with Australia's largest discount department store operations; the possibility of U.S.-based Costco stepping up its investments in the Australian store network; and potentially Amazon Fresh disrupting the industry in the longer term.

Besides a potential loss of market share to peers, intensifying price competition poses a threat for the industry. Low food price inflation below wage and rent hikes may result in operating margin pressure. From a macroeconomic standpoint, a prolonged period of weak consumer spending growth might weigh on earnings.

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