Colin Kruger
February 11, 2012
The Age
Price deflation puts the squeeze on supermarkets, writes Colin Kruger.
While discretionary retailers like David Jones and Myer have been hit for six over the past year as customers continue to be very discrete with their retail spending, supermarkets like Coles and Woolies have proved to be a more steady investment, as you would expect from the grocery end of the retail business.
But it does not mean life has been easy in the supermarket aisles. Share prices for Woolworths, Coles owner Wesfarmers, and grocery wholesaler Metcash are below last year’s levels.
Interestingly, it is Wesfarmers that has fared the worst despite analysts generally agreeing Coles has the best prospects of this triumvirate, which account for 90 per cent of food and liquor sales in Australia.
Mind you, Coles is just one rather large business in the Wesfarmers conglomerate which ranges from a recently challenged insurance business to booming coal.
”We believe that Wesfarmers is now at the cusp of strong earnings growth for a lengthy period of time,” said Merrill Lynch analyst David Errington, who has a buy rating on the stock despite concerns over the gap opening up between Woolies’ expanding floor space and Coles.
It’s the flip side of what many analysts praised about the recent Coles result, where it managed to triple the same store sales of Woolworths in the December quarter in food and liquor.
There is nothing low quality about Coles’ same store sales growth, which means it is generating increasing sales of a relatively static cost base compared to Woolies, which is generating sales the more expensive way with new stores.
Errington’s point is that there is only so long Coles can generate this growth compared to Woolies, which has added 335,000 square metres of supermarket space since 2008.
Rising price deflation – generated by falling fruit and vegetable prices as well as the industry’s price war – has not helped either Coles or Woolies.
But this is expected to be temporary as fruit and vegetable prices cycle through a rare 12-month patch that started with flooding and storms, which sent produce prices rocketing, to a present abundance that means prices are now unseasonably low.
A return to normal food inflation levels, while likely to take time, will provide an earnings boost for both companies compared to the current environment where produce prices are falling but store costs rising.
Woolies is also addressing the issues that slowed earnings growth last year. The company is finally ridding itself of the distraction that is Dick Smith and opening hardware stores that get it into a market that has been a shining light for Coles.
But slow momentum in its food business and the start-up losses associated with the new business means earnings growth will be in the low single digits for the current financial year. Most analysts are neutral on the stock.
While often seen as the poor cousin of Australia’s supermarket sector, Metcash’s share price has performed relatively well despite being caught between the twin boulders of Coles and Woolies.
The Metcash ace is the successful purchase of 80 Franklins stores last year for $215 million. The stores are being sold to its supermarket customers, which feeds back to Metcash as more wholesale business and earnings.
It led to an earnings upgrade at last year’s annual shareholders meeting.
But most analysts are keeping an eye on the inevitable relentless competition from its larger rivals.
Deutsche Bank’s retail analysts said while the Franklins acquisition will deliver ”meaningful earnings growth … the underlying grocery wholesaling business is not without challenges given slowing volume growth, high levels of promotion and food deflation, which may be exacerbated by the major chains’ plans to increase the penetration of private label”.
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