Intelligent Investor: James Carlisle

It was great fun for the supermarkets while it lasted, but the pandemic has changed the way we shop

After the party, the hangover. But it was Woolies, rather than Coles, that remembered to drink a glass of water before bedtime. While the recent interim results showed that like-for-like sales growth remains elevated, for Woolworths it slowed from 11.5% in the first quarter to 7.1% in the second and from 9.7% to 5% for Coles.

As the chart shows, both companies now lag overall food industry sales growth of 13.9% and 10.8%. Yet it is Woolies outperforming Coles on key industry metrics.

What’s going on? The pandemic has brought about a shift in how people shop, with many preferring local stores over major shopping centres.

The relatively strong performance from Coles Express, which saw like-for-like sales growth of 9.9% in the half, made the point. Sales growth in this division, which focuses on convenience locations like service stations, was almost twice that of the overall group.

The full-year results from Metcash, owner of the IGA chain of smaller and more locally based supermarkets, are likely to emphasise it. The pandemic has made local shopping more popular.

Online sales are another beneficiary of the pandemic, although the results showed that this trend is also moderating. In this category, though, Woolworths didn’t just beat Coles; it beat everyone. With online sales growth of 100% and 83% for the two quarters, it was well ahead of industry growth of 81% and 69%. Coles, delivering figures of 57% and 40% respectively, was the clear laggard. Woolworths’ Australian supermarkets business also appears to have begun the current quarter in better shape with like-for-like sales growth of around 7% in supermarkets, compared with 3% for Coles.

The buoyant conditions helped both businesses expand their gross margins, particularly Coles, which saw a 0.7% increase to 25.8%, while Woolworths’ nudged 0.1% higher to 29.2%. These increases fed into higher earnings before interest and tax (EBIT) margins, in spite of Covid-related costs, with Coles’s margin rising from 4.8% to 5.1% and Woolworths’ rising from 5.6% to 5.7%.

Both companies also enjoyed good results from their liquor businesses, which were helped by more people drinking at home.

Woolworths’ Endeavour Drinks business increased EBIT by 24% to $419 million (20% of the group total) and the Coles liquor business increased EBIT by 37% to $104 million (10% of the group total). Woolworths’ management said it was still expecting to separate

Endeavour “via a demerger or value-accretive alternative” by June 2021.

Woolworths also got a boost from its Big W department stores, which more than tripled EBIT to $133 million (6% of the total) as the turnaround met the pandemic-driven boom for homewares.

Overall, both Woolies and Coles saw healthy increases in EBIT, of 11% and 12% respectively, but they won’t match that in the second half, as comparisons are made with the panic-buying period in 2020.

Woolworths noted that “sales for all group businesses (except hotels) are expected to decline in March to June compared to the prior year”, while Coles was more equivocal, warning that “supermarket sales and EBIT growth are expected to face challenges” in the second half.

The supermarket landscape has long been dominated by a hotly contested duopoly of Woolworths and Coles. According to IBISWorld, the four largest operators account for almost 80% of total industry revenue, while the big two account for 60%.

The pandemic is unlikely to affect those market shares much over the long term. That’s why these two stocks have become staples for conservative, riskaverse investors. The latest results make a clear case for Woolworths over Coles but, as ever, it all depends on the price.

Woolworths’ share price has risen since its 2020 full-year result, putting it on a multiple of around 27 times the $1.51 of earnings expected for the current year. That puts it closer to our sell price than to our buy price, although it remains a hold.

Coles, by contrast, has fallen substantially since its 2020 result, putting it on a multiple of about 21 times the 76¢ of earnings expected for the current year. We think it deserves a slight discount to Woolworths, particularly in light of its recent underperformance. Being closer to our buy price than our sell price, it too is a hold.

Many people now prefer local stores over major shopping centres