Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn
About

News

Jump in grocery prices supports supermarket profits, for now

Nicki Bourlioufas  |  17 May 2022Text size  Decrease  Increase  |  
Email to Friend

Australians are returning to supermarket shelves to find their go-to fresh foods have leapt in price. Vegetables and beef and veal are up 12.7% and 12.1%, respectively, over the past twelve months. But what’s bad for consumers is good for supermarket giants Coles and Woolworths, as growing inflation boosts sales as prices rise. The question for investors is how long this trend will last?

Speaking to Morningstar, equity analyst Johannes Faul expects rising grocery prices to boost supermarket earnings in the near term. However, he warns the boost to earnings is “temporary” as inflation tapers off, leaving Coles and Woolworths overvalued.

Faul forecasts prices will moderate from fiscal 2023, with food price inflation expected to average around 2.5% over the subsequent decade. 

“Food price inflation is well and truly underway in Australia and we continue forecasting supermarket shelf prices to rise by mid-single digits in the second half of fiscal 2022,” he says.

“We expect these abnormally high price increases to bolster supermarket earnings in the near term, offsetting the rising cost of goods sold, higher energy prices, weak population growth, greater out-of-home food consumption, and temporarily bloated supply chain costs because of COVID-related disruptions and demand volatility.

“However, we forecast this tailwind to moderate from fiscal 2023, with food price inflation averaging around 2.5% in the subsequent decade. The Australian government expects inflation to moderate over the medium term too.”

On a relative basis, Faul prefers Coles over Woolworth, but both supermarkets are overvalued with fair values of $25 and $13.60 respectively. Coles closed on Wednesday at $18.71 and Woolworths at $37.68.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

“Current share prices suggest the market is more optimistic on the profit outlook for Woolworths and Coles. However, we expect structural challenges to limit their sales and earnings growth at around 4% over the next decade,” he says.

If a prolonged period of inflation occurs, Faul says this could drive greater sales and earnings growth and present an upside risk to fair value. But, he anticipates stubbornly high inflation--above the Australian Reserve Bank’s 2%-3% target range--to trigger interest rate hikes and weigh on price to earnings ratios.

Over the year, the prices of grocery foods as measured by the consumer price index (CPI), jumped 5.3 per cent from a year earlier. That contrasts with more modest inflation for meals eaten out and takeaway food, which rose 2.6%.

Fruit and vegetable prices combined rose at an annual rate of 6.7% due to “Covid-related supply chain disruptions, and high transport and fertiliser costs”, according to the Australian Bureau of Statistics. The prices of non-durable household products such as cleaning and personal care products jumped 8%, much greater than the CPI rise of 5.1%.

Grocery products, quarterly and annual movement

Source: Australian Bureau of Statistics

Higher prices for goods do not automatically expand supermarket margins. While prices are rising for consumers, so are the input costs for supermarkets, including wages, energy and supply disruptions. The question is whether supermarkets can pass on inflationary pressures to consumers that exceed their input costs, and whether consumers will respond by continuing to buy goods at the same quantity and rate as they did before prices rose. This is a relatively safe bet as ‘grocery’ is a non-discretionary category – people must eat – but preferences may change.

Price competition between stores is also important. For example, discount stores help prevent the larger chains from increasing prices too far.

Morgans analyst Alex Lu also believes Woolworths is fully valued but has a positive outlook. He says Woolworths delivered a commendable third-quarter sales result despite operational challenges related to Covid-19, supply chain bottlenecks and widespread floods in eastern Australia.

“With food demand being relatively inelastic, we think the company should continue to perform well in a higher interest rate environment. However, trading on 27.6 times fiscal year 2023 price-earnings, and 2.6% yield, we see Woolworths as fully valued,” says Lu who has a ‘Hold’ rating on the stock.    

As for which supermarket is performing stronger, Faul says that for three consecutive quarters, narrow-moat Woolworths has outperformed Coles in sales growth and gained grocery market share.

“The sales of the group's core Australian food segment—which we estimate to account for 86%of operational earnings in fiscal 2022—increased 5% in the third quarter of fiscal 2022, assisted by bourgeoning shelf price inflation. This compares with 4% sales growth at no-moat Coles' Australian supermarkets for the same period.”

is a Morningstar contributor.

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend