Woolies Blows It!

16 Comments

1. 

   Timothy
   November 3, 2015 at 9:30 pm:

   Thanks Roger.

   Your suspicions around WOW have been realised, as have many other defining positions taken (and avoided) by Montgomery Funds throughout this challenging year. Congratulations on your results, transparency and insights.

   • 

     Roger Montgomery
     November 4, 2015 at 9:52 am:

     The team here really appreciates the encouraging words Timothy.

2. 

   Timothy
   November 2, 2015 at 10:04 pm:

   Thank you for all the insights into WOW and sharing your investment approach in Value.able.

   With all due respect, I understand that Montgomery and Magellan – both asset managers of the highest quality – are closely aligned and co-investors in one another. In fact, Magellan holds one of the largest long positions in WOW, and is advising WOW on strategy. (Disclosure: I have interests in both companies.)

   May I therefore enquire how Montgomery asserts this opposing (negative) position on WOW? Do some friends possess deeper insights?

   • 

     Roger Montgomery
     November 3, 2015 at 5:17 pm:

     Hi Timothy,

     Just because we are friends and share the same investment philosophy does not mean we agree on everything. We sold out of WOW late last year and believe that its outlook renders it less than able chip for the next decade or so. We could be wrong. The current price action may just be noise.

3. 

   Justin Carroll
   October 31, 2015 at 8:23 pm:

   I question the thesis that WOW’s declining performance is a circumstance that it has brought upon itself through its Masters adventure and taking its focus off its customers.

   These issues haven’t helped but it is an iron law of economics that excess returns on capital will sooner or later be competed away unless a business has a sustainable competitive advantage.

   WOW had for many years a return on capital that was unusually high for what is a run-of-the-mill retailing business. Of course, people used to argue that WOW owed those returns to a competitive advantage in its logistics network, in its store locations and in its pricing power over suppliers. In my heart of hearts I was always unconvinced by those arguments. Competitive advantages they may have been. Sustainable they were not, as Aldi and others are now showing as they move into Australia.

   With the benefit of hindsight, I think two of the reasons that WOW was able to earn the returns that it was able to for so long were due to:

   1. the Australian grocery market being a duopoly in which only one of the players, WOW, was operating at an optimal level; and

   2. Australia’s small size and geographical location dissuaded foreign competitors from making the capital investment necessary to compete.

   Both 1 and 2 no longer apply and we are seeing, I believe, the results. Ultimately, WOW’s operating performance is being brought down to a level more typical of a run-of-the-mill retailing business.

   For that reason, I don’t ever see WOW returning to the kind of performance metrics that it enjoyed between 2000 and 2007.

   • 

     Roger Montgomery
     November 1, 2015 at 9:04 pm:

     Neither do we. (One must remain open to all possibilities of course).

4. 

   Justin Carroll
   October 31, 2015 at 8:20 pm:

   I question the thesis that WOW’s declining performance is a circumstance that it has brought upon itself through its Masters adventure and taking its focus of its customers.

   These issues haven’t helped but it is an iron law of economics that excess returns on capital will sooner or later be competed away unless a business has a sustainable competitive advantage.

   WOW had for many years a return on capital that was unusually high for what is a run-of-the-mill retailing business. Of course, people used to argue that WOW owed those returns to a competitive advantage in its logistics network, in its store locations and in its pricing power over suppliers. In my heart of hearts I was always unconvinced by those arguments. Competitive advantages they may have been. Sustainable they were not, as Aldi and others are now showing as they move into Australia.

   With the benefit of hindsight, I think two of the reasons that WOW was able to earn the returns that it was able to for so long were due to:

   1. the Australian grocery market being a duopoly in which one of the players, WOW, was operating at an optimal level; and

   2. Australia’s small size and geographical location dissuaded foreign competitors from making the capital investment necessary to compete.

   Both 1 and 2 no longer apply and we are seeing, I believe, the results. Ultimately, WOW’s operating performance is being brought down to a level more typical of a run-of-the-mill retailing business. For that reason, I don’t see WOW returning to the kind of performance metrics that it enjoyed between 2000 and 2007.

5. 

   Richard
   October 30, 2015 at 5:20 pm:

   Has anyone had a look at what woolies looks like with big w and masters not longer part of the stable? What is the resultant ROE assuming margins to that of coles say.
   Yes Grant has some work cut out for him but woolies has spent billions of dollars more than coles over the past 10 years on their logistics / supply chain networks to have what appears to be one of the most efficient full service supermarket chains in the world (happy to be corrected). Does woolies then need to have the same margin as coles to be on the same price level ? and if so how do we understand Woolies claims that their prices are same or slightly cheaper than coles from their analysis?
   On the other hand , if woolies did have the same margin as coles then surely this would make woolies much cheaper to shop at that coles? which in turn should drive volume growth and get back to the “double loop model ” which greg foran would have delivered in continuation of the woolies business model.
   For what its worth , the lack of reallocating margin to lower prices to drive volume which was used to fund masters is showing its effect and one of the possible solutions is the sale of Big W to reset the balance sheet.

   One other thing that the sales results do not reflect is the basket behaviour. If the same people are shopping at woolies and the prices are cheaper then this will take time for a few things to happen depending on the category of shopper you are. There are those who are loyal Woolies shoppers. They do all their shopping at woolies so would be less revenue for woolies than they were say 1-2 years ago. There are those who shop at Woolies and aldi (it will take time for peoples habits to change so that they see that the extra time they need to go to aldi is no longer worth it and then those volumes may then return back to the woolies trolley). then there are those who have left woolies for coles who need to find a way back to a woolies store. This is where woolies service and cheaper business model should work its way through the system as people need to be convinced this is the case. IT wasn’t that long ago that coles was a very distant second player and within 5 years its made a wonderful comeback but is still c20-25% smaller in terms of volumes in f/l/p.
   anyway thanks for the forum.

6. 

   David Sanderson
   October 30, 2015 at 1:47 pm:

   You saw it coming and predicted well.
   Makes me extremely comfortable I have some of my very meagre funds invested with the Montgomery Fund.

   • 

     Roger Montgomery
     October 30, 2015 at 3:05 pm:

     Delighted to be working for you David.

7. 

   Gav
   October 30, 2015 at 12:12 pm:

   Hi Roger, do you feel similarly for WES, or do you think their meaningful earnings contributions from Bunnings/Officeworks, along with Kmart/Target, make them higher quality relatively speaking in this sector? Not withstanding the lower performance of their industrial division.

   • 

     Roger Montgomery
     October 30, 2015 at 3:09 pm:

     Hi Gav,

     Just a meter of time. The first to be hit is the player with the highest margin. When WOW’s margin pulls back to near Coles, they will both find themselves under pressure. keep in mind around the world Aldi operates profitably on 2% margins.

     • 

       Gaveen Jayarajan
       October 31, 2015 at 9:16 pm:

       Yeah that’s true. Though I wonder whether it is really necessary for WES or WOW to drop margins that low to maintain earnings growth and do well. They still have plenty of stores in convenient locations which is where I think a lot of the consumers choice of supermarket is based on, not just price.

     • 

       Roger Montgomery
       November 1, 2015 at 9:03 pm:

       That’s an excellent point Gaveen. Its suggests the business will survive but profit growth doesn’t come from declining sales and gross margins, of which there might be more to come. We’d suggest a bottom hasn’t been reached yet.

8. 

   Peter Baxter
   October 29, 2015 at 2:28 pm:

   As soon as I heard the announcement I went searching for Russell Muldoon’s great article from November 2014. It prompted me to sell back then. Thank you! Talking to a Woolworths’ Store Manager this morning who has been with them for 13 years – he seemed very nonplussed about what has happened with Masters and latterly Big W – they have pared back on their distribution networks apparently causing stock issues. Gordon Cairns has his work cut out.

   • 

     Roger Montgomery
     October 30, 2015 at 3:13 pm:

     Thanks for the encouraging words Peter. Here’s the article from November 26: http://rogermontgomery.com/is-aldi-a-real-threat-to-woolworths-coles/