Woolworths’ (ASX.WOW) underlying NPAT increased by 15% to $1.6 billion in fiscal 2026. Its Australian supermarkets performed strongly. Price cuts accelerated food sales momentum over the year, carrying into fiscal 2027. A pronounced turnaround at discount department store Big W boosted profits.

Why it matters: Results are in line with our expectations, and our long-term forecasts are largely unchanged. Its strategy of reviving sales growth by lowering prices is working. Australian supermarket sales growth strengthened in the second half, up 6% year on year, versus 4% in the first half.

  • Despite cutting prices, gross margins held up in the core Australian supermarkets business. The segment accounted for close to 90% of group earnings. Like its competitor Coles, lower-margin tobacco sales are supporting gross margins.
  • Woolworths is outperforming Coles. Its sales growth is tracking 2 percentage points ahead of Coles, even after adjusting for Woolworths’ successful collectibles campaign in July and August 2026. We expect Coles, in turn, to start discounting more. Long-term, we see both holding market share steady.

The bottom line: We maintain our fair value estimate of $31.50 for wide-moat Woolworths. Shares are materially overvalued, after rerating on an impressive performance improvement at its Australian supermarkets. We think the market is more optimistic about the potential of material margin expansion.

  • We expect productivity gains to be passed on to consumers by lowering prices, with EBIT margins steady at fiscal 2026 levels of 5.5%. To match current share prices, we’d have to assume EBIT margins expand by 120 basis points and remain at 6.7% long-term.

Between the lines: Big W accounted for 4 percentage points of the 13% year-on-year increase in underlying group EBIT. Its sales were up only 1%, but these sales were much more profitable. Discounting clothing items weighed heavily on its prior-year earnings.

Woolworths long term margins kept in check by competition

Woolworths is one of Australia’s largest retailing groups, operating supermarkets and discount department stores. Its market capitalisation is around $35 billion, with annual sales of around $70 billion.

Woolworths has a wide economic moat characterised by an extensive supermarket store network, serviced by an efficient supply chain operation coupled with significant buying power. It operates in the very competitive supermarket and discount department store segments of the retail sector. Intense competition has taken its toll on margins. Management has reset prices lower to drive foot traffic and increase basket sizes. Volume growth is vital for maximising supply chain efficiencies.

To contextualise Woolworths’ enormous scale advantage, its Australian food sales of over $50 billion represented about 12% of total Australian retail sales in fiscal 2026.

Key risks involve increased competition in the Australian retail landscape and reduced consumer spending. The change in ownership of Australia’s largest retailer, Coles, in 2007, was the catalyst for increased price competition by both groups to win market share, while the entry of Amazon Australia could raise the competitive bar in the future. The aggressive expansion of low-cost discounter Aldi has altered and further segmented the grocery sector and increased competitive pressure. A reduction in the rate of growth in consumer spending would affect revenue growth and could affect operating margins. Increased frugality and heightened deflationary pressures would crimp top-line sales growth, and relatively high fixed-cost leverage would affect margins.

However, Woolworths is well positioned to withstand cyclically weak consumer spending. Woolworths is a defensive stock, with food retailing generating most of group revenue and profit, a solid balance sheet, and a wide moat surrounding its economic profits.

Bulls Say

  • Woolworths’ dominant position in the supermarket sector is entrenched and, coupled with first-class management, suggests it can maintain leadership in the sector.
  • Woolworths’ operating leverage could lead to a rebound in operating margins, driving cash generation that funds expansion and acquisitions while allowing capital-management initiatives.
  • The refurbishing of the existing supermarket fleet and rollout of revised store formats with significantly improved service, convenience, and product offerings could increase store productivity and lead to higher sales growth.

Bears Say

  • Strong online sales growth reduces store productivity and could weigh on operating margins at some retailers, including Woolworths.
  • Increased competition from Coles, an aggressive Aldi, and independents serviced by Metcash is likely to keep competitive pressures elevated and constrain operating margins.
  • Having exited petrol retailing as well as the liquor and hotels categories, Woolworths is less diversified and depends on the fortunes of its supermarket businesses in Australia and New Zealand.

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