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Woolies, Coles outpace rivals, but headwinds persist

Glenn Freeman  |  07 May 2019Text size  Decrease  Increase  |  
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Australia's largest supermarket Woolworths maintained sales growth momentum in third-quarter fiscal 2019 despite persistent competitive and structural challenges.

Woolworths (ASX: WOW) widened the gap with second-place holder Coles (ASX: COL) during the quarter, though Woolworths' advantage will be short-lived, says Morningstar equity analyst Johannes Faul.

The two incumbents continue to grow at similar levels, with like-for-like sales growth of 3 per cent year to date, according to sales figures released on Friday.

Faul estimates Woolworths and Coles will continue to grow sales at similar average rates over the longer term, as they have done in the recent past. Only 10-basis points have separate Woolworths and Coles sales growth over the past 15 quarters – a battle which has enabled discount German grocer Aldi to close the gap.

"Fortunately for the two market leaders, less-competitive independent grocers including Metcash's (ASX: MTS) IGA banner group acted as the main market share donors for the German discounter," Faul says.

On the back of the Woolworths sales figures, Faul maintains his $24.50 fair value estimate. Woolworths share price declined slightly to $32.42 by midday Friday and opened Tuesday at $32.51.

Key structural challenges include rising wage costs on the back of an enterprise bargaining agreement struck in January and the "rampant growth" in online food sales – which are cost-intensive and provide little margin uplift for either Woolworths or Coles.

For supermarket retailers, selling their largely lower-valued items online is costly given the time, staffing and fuel costs involved in picking, packaging and delivering them.

Morningstar views online food sales as barely break-even, yet e-commerce transactions jumped by 35 per cent and contributed more than one-quarter of the 4 per cent growth in food sales over the quarter.

"While online sales continue to increase at multiple times the rate of brick-and-mortar sales, we expect the margin-dilutive effect of those to become more pronounced," Faul says.

On the other hand, Woolworths' sales growth was buoyed by a decrease in price deflation during the quarter, which fell to 1.7 per cent from 2.3 per cent in the second quarter – excluding tobacco, fruit and vegetables.

The third-quarter also saw Woolworths' liquor and hotels segment rebound slightly more than anticipated, as sales grew 5.9 per cent. But management expects earnings before interest and tax to decline in subsequent quarters - mainly because of a shift to lower-market beer and spirits from more profitable wine products.

Woolworths' long-running underperformer Big W also recorded a 7.4 per cent uptick in sales for the quarter, but Morningstar doesn't anticipate a return to profitability during fiscal 2019.

Management continues to flag a loss of between $80 million and $100 million for the discount department store.

But over the longer-term, Faul expects Big W's higher margin apparel category to "catch up and underpin a return to profits and EBIT margins of 2 per cent".

is senior editor for Morningstar Australia

Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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