Kaufland set to reignite grocery price war: Citi

ELI GREENBLAT

MAY 24, 2019
The Austalian

The arrival of German discount supermarket Kaufland could be the catalyst that disrupts the $90 billion grocery sector and snaps it out of its rational pricing behaviour, reigniting a price war.

Competition is set to intensify when Kaufland opens its first string of stores in 2021.

And going on overseas experience, the arrival of grocery discounter Lidl Australia five years later could deal another price shock to the sector and further erode market profitability as Woolworths, Coles and others scramble to compete on price.

Such concerns have prompted Citi to downgrade Woolworths to a “sell” and Coles to a “neutral”.

A new report from Citi analyst Bryan Raymond argues that Kaufland could be a catalyst for disruption when it opens its big-box stores selling products such as grocery – both fresh and packaged – general merchandise, clothing, toys, homewares and hardware.

Woolworths and Coles have recently eased back on the intense price wars that for years crunched profit margins for all players. But that setting could be up-ended by Kaufland, with the price wars set to break out once again.

“The Australian grocery market has been rational over the past 12 months, however we expect competition to intensify once Kaufland enters the Australian market in 2021,’’ Mr Raymond said in a note to clients today.

“We expect Kaufland’s entry to be a catalyst for a return to private label price competition, weighing on EBIT margins. We downgrade long term EBIT margins by 20 basis points, to 5.1 per cent for Woolworths and 4.7 per cent for Coles.

“We downgrade Woolworths to ‘sell’ and Coles to ‘neutral’, as downside risks are not reflected in elevated multiples.

“Kaufland’s entry will increase competition in what is currently a concentrated grocery market in Australia.”

Any price war would likely erupt in the private label space, where Kaufland has a strong offering, much like its German rival Aldi. It will be very price competitive with the private label products sold by Woolworths and Coles.

“Clearly, the extent of pricing competition remains uncertain, however we see the balance of risk to the downside as Kaufland’s traditional focus on private label and value is likely to result in elevated private label price competition, a marked shift from the current market conditions, where Woolworths, Coles and Aldi are increasing private label pricing.

“Every 100 basis points of private label gross margin pressure impacts fiscal 2025 group EBIT forecasts by -2 per cent for Woolworths and -3 per cent for Coles.”

Then there is he added threat that Lidl, which is owned by the same private company that owns Kaufland, could pose in the Australian market.

“Could Lidl follow Kaufland into Australia? Lidl has followed Kaufland into each new market after around five years. On this basis, Lidl could enter Australia as early as fiscal 2026, supported by Kaufland’s large distribution centre and broader supply chain,” says Citi.

Kaufland currently has nine confirmed sites across three states, with six in Victoria, two in South Australia and one site in Queensland.

“Kaufland is gradually building out their Australian network, with work underway on nine confirmed retail sites across three states and a large distribution centre ahead of a planned late 2020 launch date,’’ Mr Raymond said.

“Current population density implies a potential of around 190 stores in Australia at full maturity, however the availability of suitable large format sites may limit the pace of the potential store rollout.’’

Citi believes that based on independent economic assessments of Kaufland in Australia and of its offshore operations, 80 per cent of Kaufland’s overall sales mix will be derived from grocery, nine per cent from liquor and 11 per cent from general merchandise.

Kaufland’s grocery offering in other markets is similar to that of Aldi, albeit with a wider range, targeting the value-orientated customer, with a large focus on private labels, with a basic fresh offer.

The biggest victims could be the independent supermarket chains like IGA, which would be caught in the middle of a sector-wide price war and, as in the UK, see market share slide.

“The potential exists for Aldi to respond to Kaufland’s entry by reinforcing its value position, lowering its private label prices,” Mr raymond said.

“This in turn could trigger a response from Kaufland, as they look to gain share in the value segment and could result in elevated private label price competition across the market.

“While this will impact profitability for Woolworths and Coles, it would accelerate the market share loss for independents, who are less able to compete in this type of environment. As a result, this should see independents cede share, as was the case in the UK.’’