Woolworths (ASX: WOW) is Australia’s leading retail and supermarket chain serving the everyday needs and food segments. The company enjoys absolute consumer dominance in Australia due to its vast omnichannel presence and product portfolio.
The company has been under fire for anti-trust amidst a cost of living crisis, wage disputes, and relative underperformance to rivals Kmart and Coles. The company however has huge opportunities in omnichannel growth and data-driven sales.
While the stock is unlikely to show any serious upside momentum over the short-term, it is one of the ANZ region’s best quality names with major weakness factors priced in. Hence, it is a good stock to accumulate on declines.
Table of Contents
- 1 About Woolworths Shares
- 2 Massive Scale With Omnichannel Presence
- 3 Macro Environment And Lagging Divisions Are Weaknesses
- 4 AI and Digitization Of Stores Along With Owned Brands In Non-Food Divisions Are Opportunities
- 5 Anti-Trust Is The Biggest Threat
- 6 Woolworths Financials
- 7 Woolworths Shares Valuation
- 8 Woolworths Risks are Priced In, Accumulate on Declines
Woolworths (ASX: WOW) is Australia’s major household brand with a 38% supermarket market share and a physical store footprint that puts it within 10 minutes of 85% of Australians. The company’s business covers daily needs perishables (fresh/packaged food) and regular-use essentials such as clothes, appliances, etc.
Woolworths’ dominance manifests in presence across all channels of retail including supermarkets, large format stores, online shopping, an operated online marketplace, quick commerce, retail advertising, etc.
The company also operates in pet products retail through its Petstock brand and healthcare/pharmacy services through its Healthylife brand. The company is also a serious player across all formats in New Zealand.
Market capitalisation of Woolworths Shares at time of writing is about A$37.1 billion.
Source – FY24 Annual Report
Massive Scale With Omnichannel Presence
Woolworths’ (ASX: WOW) biggest strength is its market dominance in retail and the network effects that brings. Its market position meets almost all criteria of what constitutes a strong business and brings tremendous further opportunities.
Woolworths’ business is structured under 5 heads – Australian Food, New Zealand Food, Australian B2B, W Living, and Other.
Source – FY24 Investor Presentation
Australian and New Zealand Food house Woolworths Supermarkets and its e-commerce arm WooliesX.
Australian B2B houses Australian Wholesale Grocery and PFD Foods which cater to clients such as hotels, food chains, airlines, etc.
The W Living vertical hosts Big W (Woolworths’ broad retail offering spanning electronics, appliances, clothing, etc.), Petstock (Pet Food and Accessories), Healthylife (Telehealth, Pharmacy, etc.), and Woolworths MarketPlus (Woolworths Online Third Party Marketplace with brands Everyday Market, Big W Market, and MyDeal.
Lastly, the company’s Other division houses data analytics services for other brands and Cartology, a retail advertising platform across thousands of screens in Woolworths locations and online.
The company’s omnichannel presence and vast product offering across divisions and vast footprints give Woolworths a unique scale to operate multiple business models with very few competitors that share similar advantages.
For example, the company offers in-store shopping, deliveries, 1-hour deliveries, and direct-to-boot (parking lot pickups) while also operating e-commerce third-party marketplaces by leveraging its logistics infrastructure.
The company enjoys strong bargaining power with suppliers due to scale, which is key to a retailer while enjoying the same advantage with customers due to its vast presence. Its market dominance also offers new business avenues that are difficult to replicate for competitors such as Cartology, the group’s retail advertising business which has grown at a staggering 34% compounded since its launch in 2019.
Woolworths leverages its scale with customers through its Everyday Rewards program which allows the company to enhance value for customers through bundling and promotions while boosting loyalty. The company’s extensive use of data analytics allows it to leverage its customer data through its Everyday Rewards Program and build promotional strategies to increase customer value and loyalty.
The company recently began trialing member-only pricing which could further enforce competitive advantages.
Macro Environment And Lagging Divisions Are Weaknesses
A major weakness for Woolworths shares (ASX:WOW) is the ANZ region’s cost of living crisis which driving customers to cheaper format stores such as Aldi and Kmart that are growing at a much faster pace as customers have become more value-conscious over convenience.
This is also reflected in a suppression of margins at Woolworths as customers have shifted to cheaper lower-margin products. It is also facing labor issues from employees across stores to warehouses, where employees are striking owing to disagreements over wage rates and hikes.
Secondly, the company is facing stress at its ancillary W Living division that houses Big W, Big W Marketplace, Petstock, and Healthylife as these business models are yet mature and have underwhelmed investors as far as profitability is concerned.
This has prompted calls from institutional investors to spin off this division and the company’s ailing New Zealand business from Woolworths’ core business, which would bode well for investors in WOW.
AI and Digitization Of Stores Along With Owned Brands In Non-Food Divisions Are Opportunities
Woolworths (ASX: WOW) has two major opportunities ahead – building on data science strengths/AI and transitioning to cheaper owned-brand products under its W Living segment like rival Kmart.
Woolworths was an early mover in the data science space with the acquisition of Quantium in 2013 and the launch of its advertising business Cartology in 2019. The company can use its vast proprietary data to improve outcomes for suppliers/product producers and improve loyalty program effectiveness further.
The company has also been leveraging AI to improve self-checkout effectiveness which reduces costs. Recently Woolworths began experimenting with smart trolleys which guide customers through stores and highlight relevant products and promotions, smart trolleys have been shown to increase per-store revenue by 6% in some parts of Europe.
Source – FY24 Investor Presentation
The second opportunity is emulating Kmarts successful owned-brand model under the company’s ailing W Living segment. The model is reminiscent of Amazon’s model which used data to determine in-demand products and sourcing them at cheaper prices by ordering in high volume.
Owned brands for commoditised products allows lower costs due to savings on vertical integration and marketing while still allowing cheaper prices for customers on low-mid value products. For example, Kmart’s Anko electronic appliance brand and Amazon Basics have been roaring successes for both companies.
However, the owned brand model will have to be matched by effective social media marketing, which has also been another factor in Kmart’s success. The company has an additional advantage due to massive digital assets under Cartology across online and physical locations.
Anti-Trust Is The Biggest Threat
The only major threat facing Woolworths shares (ASX: WOW) at this point in time is intense regulatory pressure by the ACCC (Australian Competition Regulator) into its business practices. The company is currently under intense scrutiny for a variety of practices such as pricing, supplier relations, land banking, promotions, wages, etc.
Allegations by regulators include deliberate price inflation before promotional schemes to make products artificially attractive. Others include land banking to accumulate prime locations, not for developments but to block competitors and unfair use of market position to undercut suppliers. Any adverse rulings could alter the company’s competitive advantages or impact margins.
Regulation over data monetization could also hurt the company.
Woolworths Financials
In FY24, Woolworths’ financial performance was as follows –
Source – FY24 Annual Report
In FY24, the company reported very modest sales growth after accounting for the impact of inflation on sales figures. The company however reported heavy growth of 19% in e-commerce and delivery of 19% and 12% growth in customers while also driving the majority of EBIT growth with steadily improving profitability.
The B2B grew well after the company’s majority stake acquisition of PFD Foods which reported strong growth while Grocery Wholesale underperformed due to inventory clearing. Supply chain services grew in-line with revenue.
New Zealand Sales were a similar story to Australia with very modest growth after accounting for inflation, however, EBIT was down substantially due to costs associated with the rollout of Everyday Rewards and vast store rebranding.
Big W reported a decline in sales due to cost consciousness among consumers and lower winter sales. The latter resulted in big inventory clearance sales and a $40 million decrease in EBIT. Other factors in EBIT decline were wage pressures and costs associated with the launch of Big W Marketplace in November 2023.
The bulk of the drop in net profit stemmed from a non-cash write-down in the company’s New Zealand operations due to disappointing performance and a mismatch between fair and carrying value. Excluding the charge, Cash Flow from Operating Activities was down a marginal 8.3% owing to high-interest costs.
In the company’s 1H’FY25 trading update, the company reported a continuation of trends seen in its FY24 report with sales growing 4.5% YoY to $18 billion, again slightly better than inflation. E-commerce was again the biggest growth driver with a 23.6% increase YoY. The company also lowered guidance for FY25 to $1.48-$1.53 billion due to higher supply chain costs.
We will be comparing Woolworths shares to major rival Coles (ASX: COL) and smaller player Metcash (ASX: IGA). It must be noted that while Coles is a major rival in size and scale, Metcash is much smaller in scale which is reflected in financials.
At the time of writing (ASX: WOW – A$30.34, ASX: COL – A$19.01, ASX: MTS – A$3.310), valuations are as follows –
While Coles and Woolworths are more or less similarly valued and Metcash is cheaper for the reasons listed above, they are both suffering from similar challenges of price inflation and regulatory challenges.
Woolworths Risks are Priced In, Accumulate on Declines
While Woolworths shares are facing operational pressures due to inflation and cost-of-living crises, the company has shown resilience in maintaining sales amidst low growth in the economy and is showing promise in e-commerce and omnichannel. The company has big opportunities in e-commerce and owned brands in non-food retail while advertising is also a strong growth opportunity. The ACCC inquiries are also a consequence of the politics around price rises and previous cases have not yielded much for the regulator.
Price inflation is showing steady deceleration with prices down for the fifth quarter in a row at Woolworths and a China recovery shaping up with broad policy measures to boost demand, which would bode well for the commodity-driven Australian economy. This should bode well for both Woolworths and Coles as rate cuts combined with the reasons listed above should chart a return to growth in B2C and B2B verticals.
While recovery drivers for the stock are still on shaky ground and a short term up move is unlikely, most of the stocks major operational and macro risks are priced in. Hence, Woolworths is a a solid quality name to accumulate on declines.
