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Woolies’ struggles against interloper are just beginning

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Woolies’ struggles against interloper are just beginning

As a consumer I love it when Woolies offers lower prices. If I was still an investor in the shares of the company, I’d be much less sanguine.

Since Montgomery sold its Woolworths shares in November 2014 — above $30 — the stock has been in decline. At around $21 today, the share price could represent an opportunity to make a lot of money or an opportunity to lose a great deal more. To help resolve the dilemma, it’s worth briefly understanding how Woolies arrived at this position.

The primary cause of Woolworths’ woes is the arrival of Aldi. A further contributor is corporate governance, although there is only so much even the best oarsman can do if his boat has a leak. Aldi makes a profit globally on a 2.5 per cent margin for earnings before interest and tax. Not long ago Woolworths was reporting 8 per cent margins. Aldi can operate and expand on 2.5 per cent margins because it is simply a more efficient business.

When Aldi enters a new country, it only does so if the salaries of the employees in that country are very high. Why? Because it gives the company an immediate operating advantage. That’s the only way its model works. You see, an Aldi supermarket might have three employees in a store of the same footprint that Woolies requires 30 people. Aldi can operate with less staff because its promise is to offer the best price, not the biggest range. Where Woolies might have 30 tomato sauce products, Aldi has just one. That means it has better buying power for that tomato sauce than Woolies and Coles, even though the incumbents have enjoyed 80 per cent market share and Aldi just 10 per cent.

With fewer individual products needing replenishing on the shelves, fewer staff are required to operate the business. Aldi doesn’t enter a country unless it displays high average gross domestic product and high wages. Ideally it also likes to find territories where there isn’t already a hard discounter established. Then Aldi rolls out its 20-year plan.

Aldi is a debt-averse business and so it was always going to grow slowly because it needs to buy sites and build stores. When it gets to 350 stores, and about $3.5 billion in sales then the company is in a position to source its products locally. It is then the biggest purchaser of the products it is interested in. It then buys local and at a cheaper price than Coles and Woolies. It also demands the recipe it wants and it starts hitting Australians’ taste and quality expectations.

What can Woolworths do? To begin, they are now playing by Aldi’s rules. Their first return volley was to “invest in lower prices”. This is a euphemism for cutting prices (and cutting profits for shareholders, by the way). Woolies is discovering that it’s simply not working and they have now reported four quarters of negative same store sales growth.

Some analysts believe Woolies will recoup the lost margin from suppliers because the volume has gone up and that it will cut staff costs. But customers have long complained there aren’t enough staff in the stores so if staff are cut, presumably customer satisfaction will decline further. And whenever Woolies cuts its prices, the others, including Aldi respond meaning it will have to continue “investing” in lower prices. Nowhere in the world have incumbents survived the entry of Aldi with their margins intact.

Woolies will survive, but Aldi is here to stay and Woolies must be a smaller business (spinning off Big W, exiting Masters) and/or report lower margins and profits.

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 is the Founder and Chief Investment Officer of Montgomery Investment Management. Roger brings more than two decades of investment and financial market experience, knowledge and relationships to bear in his role as Chief Investment Officer. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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5 Comments

  1. Chris Koenig
    :

    The fairy-tail run of the big 2 is well and truly over. Obviously, 30 tomato sauces choices are an inferior business proposition to one smartly packaged tomato sauce. So, based on rationalisation of the product ranges and leaner margins, Aldi, or others, can take up the slack. Move on the dinosaurs of the past; luckily the big 2 will stay in the game but the pickings for them should will be considerably leaner. What a disappointment it was for the foray into home do-it-yourself homeware business by Woolworths major owned , Masters. It could have taken a large bight of the fragmented home improvement market, dominated by Bunnings, but, possibly through inept management, didn’t cut the custard.. There remains a significant void, which some smart organisation may fill, and the competition would be pretty healthy for the Australian consumer too.

  2. Hi Roger,
    The fall of WOW from $31+ to now $22 makes me wonder what it is regarded as A,B or C stock and whether it can recover without a change of Board given the debacle and stupidity of the Masters episode.

    • Hi there Paul, the change in share price does not affect the quality score, which is based on the underlying business. Having said that quality will be deteriorating as margins and profits are compressed. Type Woolworths into the search bar on the blog homepage and you’ll find our previous analysis there

  3. Roger, I am struggling to understand why the factors you describe as central to WOW declines have not produced the same result across the road at Coles?

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