This has been a year to forget for Australian supermarket giant Woolworths.
Its key competitor, the Wesfarmers-owned Coles, has been performing somewhat better, but its margins remain under pressure as a price war anticipated early in the year has begun to bite across the sector.
Much of this is attributable to the increased choice consumers are enjoying through the arrival of multinationals Aldi and Costco, which are aggressively undercutting prices and have more efficient operating models.
“For instance,” write Morgan Stanley analysts Thomas Kierath and Monique Rooney in a note to clients, “in Australia, Aldi employs 24 staff per store vs Coles/WOW at ~110-120.”
On some levels, fighting this is simply impossible. “We believe Aldi’s better labour utilisation is driven by multiple factors that can’t be replicated by the majors, which enables a ~6% labour cost to sales ratio vs Coles/WOW at ~10%,” Kierath and Rooney said.
The share this chart on the rapid growth of Aldi’s market share and the impact it is having on the established duopoly.
Note Aldi’s current and forecast market share, on the right axis, remains only a portion of the major players. Still, it is a telling story.
The Morgan Stanley team also have built out this forecast on what they see as an aggressive expansion by Aldi in the Australian market over the coming years. The forecasts have the Aldi network being half the size of the long-established sector leaders within five years – transformation at a blistering pace.
The price targets for Wesfarmers and Woolworths have been slashed, with the Morgan Stanley team slapping a $19 target on the latter, which is currently trading at just over $25. They believe the market is still too optimistic about the outlook for the long-established leaders in the Australian supermarket space.
While financial markets’ awareness of the impact discounters are having on the Australian market has increased, we believe many still over-estimate the incumbents’ ability to react. We believe this statement made by Woolworths in June 2014 in response to an Australian Competition Review Paper is particularly telling “Changes in volume are a key driver of profitability, and small reductions in sales volume can completely erode the profitability of retailers”. To us, this statement is a clear sign that profitability can decrease very quickly, even in a relatively stable industry like supermarket retailing, given the high fixed cost base. We think that the consensus still underestimates the magnitude of the rebase that is about to occur.
Woolworths will be quickly re-examining its strategy under new chairman Gordon Cairns and the CEO he appoints. It will not be an easy task.
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