Reports today show another global super market giant – Lidl – is preparing for an Australian launch. Discount stores like Aldi and Costco are already eating into the duopoly that Wesfarmers and Woolworths have enjoyed for decades and, along with new entrants, are likely to continue to do so. Increased competition prompts serious questions for investors in those companies.
For some years Metcash was a viable player on the edges too, as regional shoppers warmed to the idea of local and engaged owners for their IGA super markets. However, after announcing a $640 million writedown just last week, and that it would not pay dividends for 18 months, its future is seriously in doubt.
As the charts below show, Woolworths has seen a big dive in its share price over the last 12 months, to just over $27, Wesfarmers has fared a little better with a drop to just $41.76, while Metcash is the worst of the lot and is inching closer to the $1 mark, after trading as high as $4 just two years ago.

Source: Yahoo!7, Data as at 11 June, 2015

Source: Yahoo!7, Data as at 11 June, 2015
Source: Yahoo!7, Data as at 11 June, 2015
The numbers
The key financials of the companies don’t shoot the lights out either. Disregarding Metcash, both Wesfarmers and Woolworths have declining EPS growth. Woolworths looks relatively cheap at a PE of 14.2 but it’s Wesfarmers that is forecast to be able to grow DPS.

Perhaps the key here, as Switzer Super Report co-founder Paul Rickard pointed out in April, is that Wesfarmers is more than just a supermarket. Sure most of its revenue comes from retail, but with Bunnings, Officeworks, Kmart and Target contributing 49% to earnings and its Coal, Industrial & Safety and Chemicals, Energy and Fertiliser contributing 9%, it doesn’t need to be so worried about increased competition.
The other thing is the much higher margin that Woolworths has grown very accustomed to of 7.43% in Australian food, liquor and petrol, which compares to Coles’ margin of 5.3%.
“With annual sales in Woolworth’s food, liquor, and petrol division of $50 billion – a 0.50% reduction in margin means a $250 million hit to the bottom line – a 1% reduction is worth $500 million,” Paul pointed out in April.
But with competition heating up, particularly with more discount entrants, there’s only one direction that margin will be moving in the future.
The verdict
Of the eight broker views tabulated by FN Arena, four are hold or neutral on Woolworths with four sells, or underweights. At a target price of $28.77, it is currently trading at around a 6% discount.
Brokers are slightly less negative on Wesfarmers, with six neutrals, holds or equal-weights and two sells or underperforms. It is trading at a 1.5% discount to a target price of $42.27.
If I had to add more of a supermarket today, I’d buy Wesfarmers. But I don’t, and I’d much prefer to wait and see how the market looks in a year or so, and to see how Woolworths deals with the competition. I’d hate to see it go the way of some media companies that struggled with a crisis of relevance as their industry was infiltrated by disrupters.
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