Woolies is coming up empty…

Woolies is coming up empty…

Back in November last year, when the Woolworths share price was closer to $34 than the $28 it is near today, we warned that the company would be seriously challenged and profit-hobbled by the emergent giant Aldi.

In our blog post dated November 26, 2014, Russell Muldoon wrote of Aldi:

“They have succeeded in every market they have selected to operate in and the incumbents have had no response simply because Aldi is 60 per cent more efficient.  For example, rather than offering 32 different brands, sizes and types of tomato sauce as Coles and Woolies might, at Aldi you will find only one…

“Rather than spreading their buying power over 32 different sku’s, Aldi focus on the best quality product they can secure for the price they can achieve and push all of their buying power through that one product and the one supplier. The benefit of this is pretty clear – this enables the business at just 350 stores to already match or better the terms of the more established players and offer even lower prices…

“To gain some understanding of the impact a highly evolved discount grocer can have on a large incumbent take a look at Carrefour SA (PA:CARR), one of Europe’s largest food retailers [Carrefour was founded in 1959] in France and operates a network of >10,000 supermarkets [and stores and the] company employees 363,989 staff.”

“At its peak between 1998 and 2001, Carrefour generated average EBITDA margins of ~6.8 per cent and EBIT margins of ~3.8 per cent.”

“The impact of ‘hard discount retailers’ such as Aldi and Lidl has been profound on Carrefour. In 2013 margins have fallen to 4.9 per cent and 2.9 per cent respectively. The share price reaction to this falling profitability has been profound. At its peak, Carrefour SA shares traded for ~€70, today they trade at €25.”

With that background in mind, we read with interest Sue Mitchell’s piece about Woolies, citing recent broker research, in The Australian Financial Review yesterday.

Essentially Woolies is “investing” in lower prices. That means they will earn less on each item. Their response has already been tried elsewhere in the world and it has not worked.

The article also notes that they have sacked a number of marketing directors in as many years. Blaming marketing for an inferior competitive and inferior structural position is simply sad and indicates management at Woolies might be all thumbs on this one.

Here are a few worrying quotes from the ARF.

“Woolworths’ plan to cut the price of private label grocery brand to better compete with Aldi and Coles may cost the retailer as much as $1 billion, reducing earnings from food and liquor by almost a third, according to brokers.”

“Woolworths is reviewing its private label grocery strategy after admitting a week ago that consumers perceived the quality of Aldi’s private label brands to be on par or better than Woolworths’ Select brand and superior to its entry-level Homebrand range.”

Woolworths has flagged plans to add more entry-level products to its private label range and match prices on key private label items to “close the gap” with Aldi and Coles.

“We’re not going to be beaten on price relative to our major full line supermarket competitor,” Woolworths’ new Food Group managing director, Brad Banducci, told investors earlier this month. “The issue we’ve got with Aldi is providing the same value experience in our store as you would in an Aldi, which requires us to rethink and re-engineer some of our entry level products including some of our entry level own brands.”

“Mr Kierath said that if Woolworths cut the price of Select products by 10 per cent it would reduce food and liquor margins by 84 basis points to 6.57 per cent, cutting earnings before interest and tax by $388 million.”

“The retailer also needs to improve its marketing to convince consumers that its prices are competitive. Earlier this week, Woolworths confirmed it had parted ways with its fourth marketing director in as many years, with CMO Tony Phillips stepping down after a year in the role.”

“Without improved marketing, Woolworths will continue to struggle with its value perception,” said Deutsche Bank analyst Michael Simotas.

Coles is expected to outline its response to Woolworths’ plans at Wesfarmers’ annual strategy day in Sydney on Wednesday.

We wish Coles and Woolies every success. They’re going to need it.

Montgomery is no longer a shareholder in Woolworths and we argue that Woolies and Coles are no longer Blue Chips.

Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

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