Grocery prices under pressure as supermarket war threatens to escalate

Daniel Palmer
JULY 5, 2016
THE AUSTRALIAN

A full-blown price war in the grocery sector is an increasing possibility as UBS analysis suggests Woolworths is still losing ground on main rival Coles.
The investment bank had been tipping Woolworths performance would bottom-out in the second-half of this year, but is reassessing that view after its survey of 58 suppliers pointed to Coles at least maintaining its lead through until the first half of 2017.
UBS, which conducts the survey every four to six months, noted a 77 per cent correlation between the results and like-for-like sales numbers at the two supermarket giants. The latest study found Coles ahead on all 26 subcategories tested for the first time since the survey was initiated in 2007, a complete switch from when the survey began during a period of Woolworths dominance.
“There were signs of better execution [at Woolworths] in key areas such as fresh and marketing where the gap to Coles closed,” UBS analysts, headed by Ben Gilbert, said.
“[However] poor and deteriorating in-store compliance and internal culture are hurting Woolworths’ ability to translate the investments into improving sales momentum.”
The report noted that cultural and execution issues were damaging sales as the prevalence of ‘out of stock’ events hurt margins by failing to maximise promotion volumes and scarring consumer views of the business.
Downside risks are now seen for like-for-like sales at Woolworths given analysts had tipped signs of a turnaround by now.
“We (and consensus) already forecast improving like-for-like trends over FY17, but the survey results suggest our projected pace of (relative) improvement could prove optimistic,” the note read.
“The above said, the margin opportunity for WW remains significant with any uptick in sales, potentially leading to a material pre-tax earnings uplift via reduced shrink, lower negative leverage and improved terms.”
As it stands the performance gap between Coles and Woolworths is the largest ever, with March quarter sales showing the gap on like-for-like measures at 5.8 per cent.
Woolworths has underperformed its key rival for 27 straight quarters after Coles reaped the benefits of a turnaround plan initiated by Wesfarmers after it took control of the group in 2007, while Woolworths has been distracted by a costly and, ultimately failed, foray into the hardware sector.
Woolworths has seen two chief executives depart through the almost seven years of underperformance against its rival, with former food and liquor boss Brad Banducci charged with the task of reviving its fortunes in February this year.
The recovery is not expected to be swift, but the longer it takes for positive signs in its turnaround plan to emerge, the more likely a price war will break out in the increasingly competitive grocery market.
In the view of UBS, an irrational price war is now a 35 per cent chance, up from 30 per cent ahead of the survey.
“Woolworths has made ‘rational’ investments in price and service, yet these have not translated into noticeable improvements in the survey results,” the analysts said.
“The current value message is not winning back shoppers and in-store execution remains poor and is deteriorating.
“This suggests increased risk of Woolworths making ‘irrational’ further investments to drive momentum or Coles stepping up investment to maintain its like-for-like lead in a slowing market is growing.”
Suppliers are tipping price deflation over the next 12 months and while the report largely seems positive for Coles, a threat to margins points to slower profit growth.
“There are signs Woolworths is bottoming (fresh, marketing), which could trigger increased investment from Coles to ensure top-line momentum is maintained in a slowing market,” the group said.
“We believe Coles would/should sacrifice near-term margin (if needed) to ensure mean reversion does not occur.”
UBS retained its ‘sell’ rating on Woolworths, while its ‘neutral’ view on Wesfarmers now has a “negative bias”.