Why Australian companies don’t want to make too much money

No one was preaching the “greed is good” mantra when Australia’s publicly listed companies reported their financial results for the December half-year.

Australia’s corporate titans are used to weathering a brutal level of scrutiny during reporting season. But they are also used to receiving the typical payoff: the kudos of delivering a bumper profit for investors. Not this year.

Woolworths Group CEO Brad Banducci surprised the market with his resignation last week.Credit: Michael Quelch

A volatile cocktail of political and public fury over alleged price gouging by the likes of Qantas, Coles and Woolies forced Australia’s largest consumer-facing businesses to be very sensitive when it came to reporting just how much money they were making and how they did it.

If the recent example of Qantas boss Alan Joyce and his chairman Richard Goyder were not enough, Woolworths boss Brad Banducci would have rattled a few corporate cages with his surprise retirement last week as the grocery giant announced its December half results.

Just days earlier, a viral video of him walking out on a Four Corners interview – in response to claims that Australia had one of the most concentrated grocery markets in the world – captured the zeitgeist. It is an issue that will get closer scrutiny at Senate hearings this month and at an inquiry by the competition regulator.

The Woolworths result revealed a strong December half for its food business, but it was described by one analyst as the last hurrah for profit-margin-driven earnings growth as a cloud of regulatory scrutiny descends on the grocery sector.

“This level of gross margin expansion and earnings growth is likely to make Woolworths an even larger target for regulators and politicians in a period of intense scrutiny on the grocery industry,” JP Morgan analyst Bryan Raymond said.

The embattled Banducci was more focused on a tough outlook that includes rising costs and falling inflation, as well as the battle to maintain the loyalty of its customers. Investors barely rated a mention.

“Managing costs-of-living pressure remains a key issue for our customers, and we need to work ever harder to deliver value and help our customers to continue to spend less every time they shop with us,” he said.

As for the claims that the Woolies-Coles oligopoly controlled the market, Banducci had a clear response.

“This market is unbelievably competitive, it’s an inconvenient truth to many, but it is statistically, unequivocally true. The traditional competitors are getting more competitive, but then in food and everyday needs, essentially, you are seeing virtually every retailer getting to these categories because it drives traffic and basket for them. And that includes BIG W,” he said.

This week, it was Coles boss Leah Weckert who got to polish her lines about just how much good the supermarket giant was doing for cash-strapped customers as it beat market expectations and banked more than a billion dollars in earnings before interest and tax for the December half year.

“We are having to work hard every day to work out how we attract customers into our stores. And we are looking at our profit results, and we feel like we are managing to get the right balance between stakeholders, which is why you have not seen our profit margins go up,” she said.

She even mentioned how cash-strapped customers were forsaking the convenience of their well-positioned local Coles store to go hunting for cheaper prices.

“A number of [customers] were willing to hop in the car to go to places where they knew they could get good value on certain items. I do think that is becoming more prevalent in terms of the implications ... for our business,” Weckert says.

But amid the clamour to do better for their customers, some details suggested an alternative to the narrative that the Woolies-Coles colossus controls 65 per cent of the supermarket trade.

Like the fact that Woolies had managed to lift its supermarket profit margins – earnings before interest and taxes (EBIT) to be specific – above 6 per cent.

Coles CEO Leah Weckert says customers are forgoing convenience to find lower prices.Credit: Arsineh Houspian

Coles did well to lift its own margins above 5 per cent, although Weckert reverted to the company’s overall net profit margin to fend off any suggestion of profiteering: “In terms of our profit, we make around $2.60 for every $100 a customer spends — less than 3¢ on the dollar,” she says.

But the EBIT margin is of particular interest when you look at what is happening across the Tasman.

Woolies wrote down the value of its New Zealand supermarket operation by $1.5 billion. This was primarily due to an intensely competitive landscape from which there are no signs of respite.

EBIT margins were compressed to just 1.7 per cent in the December half, with aspirations to get it to stabilise around 3 per cent in the long term.

This level of profit margin may be low by the standards of Coles and Woolies but not by the standards of other comparable countries.

In July last year, the UK’s Competition & Markets Authority (CMA) debunked the myth of “greedflation” in its own grocery market with a report showing that competition is so intense that the supermarkets have been unable to pass on their higher costs to shoppers.

The UK competition authority reported that average operating margins in the supermarket sector in 2022-23 – roughly equivalent to EBIT margins – fell from 3.2 per cent to 1.8 per cent.

To give this context, Woolies and Coles’ EBIT for the previous financial year exceeded $4.5 billion. If intense competition had reduced their EBIT margins to 3 per cent, it would have put more than $1.5 billion into the pockets of shoppers.

The Australia Institute’s chief economist, Greg Jericho, says low profit margins are exactly what we should expect from a low-risk, high-volume consumer staple such as the grocery business.

“People were confusing low profit margin with low profits. They make massive profits,” he says.

“The reason they are low profit margin is because it’s a low-risk industry. They don’t add much; they take stuff from suppliers, put it on a shelf, and we come in and take it off the shelves and pay for it … There’s not a lot of risk involved.”

But in an earnings season that surprised on the upside with profit margins performing better across the ASX 200, do the supermarkets deserve such an outsized focus compared with the rest of the market?

Qantas, of course, deftly managed its results with a double-digit drop in profits from the prior December half, where earnings soared thanks to limited supply driving airfares through the roof.

“We know that millions of Australians rely on us, and we’ve heard their feedback loud and clear,” chief executive Vanessa Hudson said. “We understand the need for affordable air travel, and fares have fallen more than 10 per cent since peaking in late 2022.”

Further investment in its ageing fleet of aircraft and customer service also helps as the airline prepares for battle with the competition regulator alleging the airline engaged in deceptive conduct by advertising tickets for thousands of already cancelled flights.

But if you want to look at companies with profits skyrocketing from soaring inflation, you need look no further than toll road operator Transurban, with profit margins of around 72 per cent and tolls guaranteed to go up in line with inflation, if not more.

As analysts from Morningstar reported: “With inflation likely to remain high in the near term and a natural lag between inflation readings and toll increases, Transurban should benefit from elevated toll increases for another couple of years.”

Market strategist Jessica Amir says earnings from energy companies such as AGL and Origin “shot the lights out” this reporting season.

Jessica Amir, market strategist for trading platform moomoo, says earnings season provided far clearer targets than the supermarket sector with soaring prices and earnings in energy-utilities and insurance.

“Earnings shot the lights out, and profits were monumental in utilities,” she says with special reference to Origin Energy and AGL.

Origin more than doubled its earnings for the December half to $747 million and raised its profit guidance for the year as energy costs decreased.

AGL reported a quadrupling in interim profit to $399 million with high-power prices for its customers expected to boost earnings for the rest of this year and possibly even the next financial year.

“We didn’t see that in any other sector on the ASX [and] I don’t see any mention of price gouging?” Amir says.

Insurance was the other sector that has hit consumers with large bill rises and had investors clamouring for stocks such as QBE, which is trading at a decade high, while IAG has also hit multiyear highs recently.

“That is telling you who the key winners in the stock market are going to be – absolutely 1000 per cent,” Amir says.

But was this really representative of the corporate universe this reporting season?

While earnings from most companies surprised on the upside, this had more to do with the low expectations of investors, according to Amir and UBS strategist Richard Schellbach.

Earnings declined 14 per cent in the prior December half and were down again this year. This is not expected to change for the current half-year.

“A similar negative skew has been seen in the guidance and outlook statements which have come from company management teams,” says Schellbach.

And if there was one key theme across all companies, it was how falling inflation would make it harder to raise prices while costs – including wage increases – continued to rise.

This is as true for Woolies as it is for any other company, as it manages an underlying wage increase of more than 6 per cent while under the microscope of politicians and the competition regulator.

As Banducci said to analysts and investors last week: “It’s going to be a relatively painful transition from a world of price inflation to a world of elevated wage or input inflation and very muted price inflation.”

UBS strategist Schellbach says it is clear that businesses can no longer pump customers for more money.

“[Companies] painted a picture of a customer base which is battling against cost of living pressure and higher rates, and thus has little scope to up their spending.”

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