Woolworths and Coles feel the heat as supermarket sales drag

Sue Mitchell
Aug 9 2016
AFR
Woolworths might have become the poster child for the price war in the $90 billion supermarket sector, but arch-rival Coles has not escaped unscathed, as food deflation crimps profit margins and sales.
Coles is set to report its weakest annual earnings growth since the Wesfarmers takeover in 2007, while Woolworths’ Australian food and liquor profits are forecast to plunge 36 per cent to levels not seen since 2008.
Analysts have tweaked their 2016 sales and profit forecasts for both chains following weaker than expected supermarket sales in the June quarter, triggered mainly by escalating investment into grocery prices and deflation in fresh food.
Coles’ earnings before interest and tax are forecast to rise 5.4 per cent to $1.87 billion, with earnings growing in line with top-line sales, and margins little changed around 4.7 per cent (5.4 per cent excluding petrol).
Woolworths’ food, liquor and petrol margins are expected to fall to between 4.7 and 5 per cent, compared with more than 7 per cent in 2015, reflecting negative operating leverage from weak sales and the group’s $1 billion investment into grocery prices, service and stores.
Analysts say that while supermarket volumes are rising, deflation in fresh food and packaged groceries is eroding gains.
Supermarket sales grew by 1.9 per cent in the June quarter, less than half the 4.5 per cent growth in the March quarter and well below the long-term average of 6.7 per cent.
Weakest quarterly growth since 2005
Macquarie Equities analyst Andrew McLennan said it was the weakest quarterly growth in supermarkets since 2005, although sales growth briefly dipped to similar levels in 2010.
Anaemic industry growth, coupled with Aldi’s expansion into South Australia and Western Australia, has crimped same-store sales growth at Coles and exacerbated Woolworths’ ongoing market share losses.
Macquarie believes Woolworths’ same-store supermarket sales fell 2.6 per cent in the June quarter, compared with a decline of 0.9 per cent in the March quarter, and are unlikely to return to growth until 2018.
Coles’ same-store sales growth is estimated to have slowed from 4.4 per cent to between 2.9 and 3.8 per cent in the latest quarter, ending years of strong market outperformance.
The question for investors is whether Coles will remain rational and accept a lower rate of growth to protect profit margins, or step up price reductions to boost sales momentum.
Citigroup’s head of research Craig Woolford says that while Coles has been cutting prices on popular brands and private label products, it has been quietly raising prices on back-basket or low-profile products to bolster margins.
“Overall earnings for Coles are likely to be met for 2016, but the pace of margin expansion at Coles is clearly slowing,” Mr Woolford said.
Meanwhile, analysts say Big W’s decision to move its corporate headquarters out of Woolworths’ Bella Vista bunker, as reported in The Australian Financial Review on Tuesday, reflects Woolworths’ desire to distance its general merchandise and core food and liquor operations.
They believe the Big W move is more about attracting the right staff and improving the culture at the troubled discount department store chain rather than being a precursor to divestment or demerger.
Major shareholders have urged Woolworths to sell Big W and other non-core businesses such as petrol and hotels and become a pure-play food and liquor retailer.
However, analysts say Big W, liquor and petrol complement Woolworths and an asset sale could have unintended consequences.
“By selling it (Big W) they create a new competitor for themselves,” one analyst said.
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