Deutsche Bank is worried about the prospects for Australian supermarket giant Woolworths, and how it might survive the onslaught of a price war looming in the sector.
In a recent note to clients, gun sector analyst Michael Simotas revised the price target for Woolworths from $37.50 to $30.00 and cut its recommendation from Buy to Hold.
The Woolworths offering is the more premium of Australia’s two big supermarket chains, the other being Coles of the Wesfarmers Group. Deutsche Bank interpreted updates from management last week as a signal that another price war is coming, which is good news for Australian consumers but will inevitably squeeze margins at Woolies, one of the favoured stocks among Australian retail investors.
And there’s a more visible problem. Have you noticed some of your favourite products have been harder to find at Woolworths lately? Deutsche has, and believes it’s a sign of troubles at the retail giant, reflecting a decline in customer service culture and penny-pinching on staffing levels.
Shoppers are buying less stuff when they go to Woolies, and Deutsche thinks the staffing might be part of the problem.
Industry feedback suggests that Woolworths on shelf availability has deteriorated over the past few years, and has become particularly problematic in recent months. The CEO agreed that this had become an issue and did not deny that this was a result of labour hours being cut too aggressively. Interestingly, the key driver of the recent sales weakness has been a reduction in items per customer. Poor on-shelf availability clearly could have been a factor in this. Some of the reinvestment will be made in this area. We believe that labour is only part of the problem – we also believe there is a cultural issue which must be addressed.
Although Woolworths just posted a strong first half result with underlying EBIT up 4% to $2.1 billion, Simotas writes:
the 1H numbers were a sideshow given the guidance cut and plans to make heavy investments vindicate the view that margins are unsustainably high. Underinvestment in labour has been a key issue which has manifested itself in poor on shelf availability. Reinvestment may improve this but the majority of the $500m+ spend will need to fund price reductions. This concerns us given WOW is a big ship to turn and management may need to spend more than it thinks to improve the value perception, particularly given competitors are likely to retaliate. Cut to Hold.
It’s not just Woolworths that might be feeling the pressure this year, however. Deutsche predicts a looming price war that could feed itself:
The CEO was very clear that Woolworths needs to be cheaper in order to restore its value perception. While we agree that Woolworths’ value perception has slipped and price investment should help to improve it, we are concerned that this investment may be just the beginning. Notably, $500m represents over 1% of Woolworths’ supermarket turnover and 14% of divisional EBIT. We are concerned that Woolworths may need to spend more than management thinks in order to improve the value perception. It takes time to improve perceptions and Woolworths is a big ship to turn. In our opinion, both Coles and Aldi are likely to retaliate when prices begin to fall, and this $500m investment may be just the beginning. This could lead to a period of sharp deflation, low sales growth and declining profitability for the industry.
The stock was on a high of over $34 last week but crashed below $30 after its results were announced. The stock was at $29.37 this morning.