At the start of the year, I moved Woolworths (WOW) out of our model portfolios and replaced it with Coles. This was largely on the basis that Coles was too cheap compared to Woolworths, and the gap between the two companies was starting to narrow.
It was also before the then CEO of Woolworths Brad Banducci’s “horror” interview with Four Corners and much of the pile on about “price gouging”, which seemed to be targeted more at Woolworths than Coles.
Perhaps unsurprisingly, Coles has clearly outperformed Woolworths this year. At a financial level, sales growth in FY24 of 5.7% compared to Woolworths 3.7%, EBIT growth of 7.3% compared to Woolworths 1.1%, and underlying NPAT growth of 4.1% compared to -0.6% for Woolworths.
For shareholders, the performance has been even more impressive. Coles shares are up 16.0% since the start of the year and have returned 68c in dividends (for a total return of 20.2%). Woolworths shares are down 6.6%, but with dividends, the loss lessens to 2.7%. Overall, the performance swing is around 23.0%.
Historically, as the market leader, Woolworths has traded on a higher multiple (chiefly the price/earnings multiple) than Coles. However, this gap has narrowed with Coles shares outperforming. Both companies have now tabled their financial reports for FY24 and given the market an update on trading conditions over the first eight weeks.
Looking at this information, is Coles going to continue to outperform, or will the pendulum swing back to Woolworths? What do the brokers’ say? Let’s review and see whether we can answer the question, Coles or Woolies?
What I like about Coles
Arguably, Coles is a simpler business than Woolworths. Supermarkets and liquor stores (in fact, 856 supermarkets and 992 liquor stores, the latter largely branded as Liqourland, Vintage Cellars or First Choice). It doesn’t have the operating challenges of the BigW discount department store chain, the food supermarket business in NZ, and is not into wholesale food distribution or supply chain management that Woolworths has moved into.
That’s not to say that the liquor business doesn’t have its own challenges. Due to the squeeze on the consumer and long term consumption trends, comparable store sales in liquor for Coles fell by 1% in FY24 and earnings declined by 14% to $144m, less than 7% of the Group’s overall total.
Coles is currently winning the “sales war” with Woolworths. In the second half, it grew comparable store sales in Australian supermarkets by 2.6% compared to Woolworth 1.2%. For the first eight weeks of FY25, it reported sales growth of 3.7% compared to Woolworths “around 3.0%”.
It has also improved its margins, with the EBIT margin increasing by a “normalised” 30bp to 5.4% in FY24. This is still less than Woolworths’ Australian Food, which achieved a margin of 6.1%.
For the last few years, Coles has been building new automated distribution centres. These are largely complete, with Redbank in Queensland and Kemps Creek in NSW ramping up. As a result, capital expenditure is forecast to fall from $1.4bn in FY24 to $1.2bn in FY25.
What I like about Woolworths
Woolworths is the market leader, with supermarket sales of $51bn compared to Coles $39bn. It has a higher EBIT margin than Coles: 6.1% compared to Coles 5.4%.
It is the clear leader in digital/ecom sales, with 13.4% penetration compared to Coles 9.4%. It has invested heavily in data and analytics, and claims that digital visits now exceed store visits.
Source: Woolworths
It has an opportunity to improve the woeful performance of the BigW discount department store, which in FY24 contributed just $14m in EBIT (Australian Food in comparison was $3,100m). The NZ Food business (NZ supermarkets) is also struggling, earning Woolworths $100m in EBIT, down 56% on FY23. Woolworths also booked a significant loss of $1.5bn on writing down the value of the NZ business.
Woolworths has made a significant play into “business to business” (B2B), purchasing wholesale grocery and food distributor PFD, becoming involved in the preparation and packaging of food with The Australian Food Company and developing a logistics business with Primary Connect. In FY24, sales from the B2B business rose by 6.1% to $4.6bn and EBIT rose by 87% to $122m.
In FY25, capex is forecast to rise marginally to between $2.0bn and $2.2bn (compared to $2.0bn in FY24), as Woolworths invests in store renewals and supply chain improvements.
Post its financial results, Woolworths sold the remaining shareholding (about 5%) in Endeavour Drinks (EDV). This means that Woolworths now has no exposure to liquor or gaming. The funds will be used to pay for the remaining part of PFD, taking Woolworths to 100% ownership.
What do the brokers say
While the brokers on recommendations favour Coles, when it comes to the target price and implied upside, it almost identical. The brokers see 6.4% upside for Coles (based on Friday’s closing price of $18.68) and 7.0% upside for Woolworths (based on Fridays closing price of $34.64).
The Brokers expect a small improvement to Coles margin in FY25 and a small increase in earnings. They have Coles trading on a multiple of 21.8x forecast FY25 earnings and 19.1x forecast FY26 earnings.
For Woolworths, the brokers question whether it may have to discount to win back market share and consumer trust. Overall, they see a small increase in earnings, and have it trading on a multiple of 24.6x forecast FY25 earnings and 22.7x forecast FY26 earnings.
Bottom line
In somewhat of a “line-ball” call, I favour Woolworths going forward. This is largely on the basis that the gap on PE multiples has narrowed into around 15%, well below the historical norm of over 25% that Woolworths has commanded. Woolworths investment in digital and B2B provides a stronger platform for long term growth.
New Woolworths CEO Amanda Bardwell’s “back to basics” strategy, which fundamentally involves improving customer service and building trust, should assist. The risk is that a level of price discounting occurs, eroding margins.
The market will watch closely the sales figures and the progress each company is making. The next round (first quarter sales) is due in early November, which may be the catalyst for a re-assessment by the market.
I don’t expect the market to suddenly fall back in love with Woolworths (at Coles expense). But in due course, reversion is expected and this is the time to position for it. Buy Woollies, sell Coles.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
