Woolworths can reverse its fortunes - because Coles is killing it

Marianna Massey/Getty Images for Woolworths

Woolworths last week posted stalled sales growth and less than impressive profits.

But there’s a reason to be optimistic: Woolies’ key competitor, Coles, is doing great.

Coles has shown the supermarket model still works and can be profitable.

“I think that the performance of Coles is extremely encouraging and suggests that Woolworths is fixable,” Gareth James, senior equities analyst at Morningstar, told Business Insider.

Earnings before interest and tax (EBIT) at Coles increased 6.6% to $1.783 billion for the year.

At Woolworths, EBIT increased 2.1% to $3.439 billion on food, liquor and petrol.

“We do believe that the company can be turned around,” James says. “There’s a few positives within this result as well even though on the surface it looks negative. But we take the view that Woolworths has had an absolutely terrible year. Most of the senior executives seem to have left the company.”

The loss from the Masters home improvement business at Woolworths was $225 million which works out about 6% of group EBIT.

“Assuming that that situation is not going to continue indefinitely – either it’s going to be sold or shut down or turned around – that does provide a potential for an earnings kick,” James says.

James rates the replacement of current chairman Ralph Waters with Gordon Cairns, a former CEO at Lion Nathan and chairman of David Jones, as a big positive.

Gordon Cairns. Ross Land/Getty Images

Cairns’ first job is to find a replacement for CEO Grant O’Brien, who announced in June he was stepping down after what he called disappointing results.

“The result from a financial perspective wasn’t really a surprise,” James says. “The change in chairmen is a really positive step. It’s something we have been expecting for a while now.

“And we think Gordon Cairns is a good person for the job. He’s going to do a good job and that’s going to speed up the appointment of a CEO.”

The move was made at the same time the company announced a worse than expected slump in profit, down 12.5% to $2.146 billion. Revenue fell 0.1% to $61.15 billion.

And the company says there won’t be growth for the next six months.

Deutsche Bank is forecasting profit to fall 6.8% to $2.286 billion 2016. “While the FY15 result was in line with our expectations, we have reduced our estimates,” say analysts Michael Simotas and Daniel Wan in a note to clients.

“While we see some value in what is still a high quality set of assets, with earnings set to decline in FY16 and the potential for a further rebase from a new CEO, we believe it is too early to invest.” Deutsche Bank has a Hold recommendation on Woolworths.

At Coles, food and liquor sales were up 5.3% for the year. At Woolworths, Australian Food, Liquor and Petrol could only manage 2.1% growth, less than inflation.

This chart from Deutsche Bank demonstrates the clear lead Coles has in sales growth:

Both big supermarket groups are under attack from new entrants. Aldi, the discount German group, has been making inroads across Australia, picking up an 11% market share, and now is concentrating on the AUstralian east coast.

But Coles is still growing.

“If Coles can win in this market than that suggests that Woolworths’ problems are not just about the hard discounters, it’s about Coles winning against Woolworths,” James says.

“That suggests there is hope because we think that Woolworths can beat Coles. Aldi is incredibly difficult to compete against and Woolworths imply cannot match their prices.

“But against Coles it can win.”

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