Challenges mount for Woolworths

Woolworths’ quarterly sales result is impressive, but the retailer is still in recovery mode.

The 4.9 per cent increase in Woolworths’ comparable stores sales in the first quarter is impressive, but the retailer is still in recovery mode. (AAP Image/Paul Miller)

Woolworths is maintaining the sales momentum within its supermarket business that is has generated over the past year. The challenge of continuing that run, however, will mount as this year progresses and it won’t be until the group reports its earnings for the first half of the financial year that the cost of that success becomes clearer.

At face value the 4.9 per cent increase in Woolworths’ comparable stores sales in the first quarter, to $9.63 billion, is an impressive achievement. It looks even more impressive when compared with the first quarter growth of only 0.3 per cent posted by its arch-rival, Coles, last week.

Comparisons are, however, somewhat distorted by the reality that Woolworths is still in recovery mode. A year ago it posted comparable stores sales growth of 0.7 per cent, which was rightly hailed as a major positive because its sales base — both in headline and comparable stores terms — had previously been shrinking.

Thus the group is still cycling relatively weak numbers on a year ago and, having invested something substantially over $1 billion in price and service since Brad Banducci became chief executive 18 months ago, it would be disastrous if it weren’t posting relatively strong numbers.

The first quarter growth in total supermarket sales of 4.7 per cent is, in fact, well below the 7.2 per cent generated in the preceding quarter and the 6.4 per cent Woolworths achieved in the second half of last financial year — the rate Banducci said at the time he thought the group could continue to achieve. Price deflation — average prices, excluding tobacco, were 4 per cent lower in the quarter (2.4 per cent if tobacco is included) — did dampen the growth rate.

It will, however, be increasingly difficult to sustain even the current rate of sales growth as the comparable numbers from last financial year continue to strengthen and as Banducci inevitably starts to share the focus on sales growth with a greater emphasis on the cost to earnings of achieving that growth.

A year ago he had no option but to invest whatever it took to ignite some growth and start clawing back the market share it had lost to Coles. Last financial year that was reflected in a 2.4 per cent slide in supermarket earnings before interest and tax.

With Coles responding with its own big investments in lowering prices and improving service both supermarket chains are wearing scars from the increased competitive intensity within their P&Ls.

That would normally discipline their pricing over time. With Aldi continuing to build market share, Amazon clearly on the horizon and Lidl’s younger sibling, the Kaufland hypermarket chain acquiring sites, however, the sector has no “normal” settings to revert to.

The encouraging aspect of the quarter for Banducci and his team, apart from the bottom line that they are winning back share, is that the non-financial metrics within the supermarket business continue to improve.

Customer satisfaction levels continue to improve as the investment in service produces returns in the form of higher transaction numbers and growth in basket sizes. Price perception also continued to improve but Woolworths still sees that as an opportunity.

Banducci would be pleased that what is ultimately a relatively simple strategy to regain price competitiveness — which doesn’t mean it’s easy to implement — is being executed well and is being reflected in all the key performance indicators.

He’d also be encouraged that, within his troublesome Big W discount department store business, the implosion of its sales base has (for the moment at least) been halted.

Big W posted total sales growth of 2.5 per cent for the quarter and comparable stores growth of 2.9 per cent. Given that the sales base was shrinking at a rate of more than 5 per cent in the same quarter of last financial year, that’s a more modest achievement than it might initially appear.

Nevertheless, Big W is getting growth in its transaction numbers and basket sizes.

Inevitably there will be a cost to halting the haemorrhaging of the sales base. Having lost $150.5 million last year Woolworths has foreshadowed a similar level of losses this financial year and continues to describe the attempts to return Big W to profitability as a “multi-year journey”.

Having finally buried in the past the financial impacts of the disastrous foray into the home improvement sector, Woolworths is a smaller and less complex group — and the Big W losses become far more visible.

Woolworths can’t simply shut down the brand because of the scale of is lease commitments and it is unsaleable at any price in its current condition, so Banducci has no option but to take a medium term and optimistic view of its potential to recover.

Given the torrid conditions in the sector — in discretionary retailing generally — and the similar time frame for the efforts to stabilise the Coles’ sibling, Wesfarmers’ Target chain, there, however, is no certainty that the journey will end happily for either brand.

Last financial year Target did end the flood of red ink it has generated in recent years but its sales base continues to shrink as it tries to reposition its offer. The continuing success of Target’s sibling, K mart, is almost certainly a part of the explanation for the extent of the woes within Target and Big W.

Coles’ John Durkan, while putting a lot of effort and dollars into trying to counter Woolworths’ resurgence in supermarkets, has also been investing time and capital in what was a perennially underperforming liquor business and appears to be encouraged by the early signs of improvement even though comparable stores sales growth appears to be only minimally positive.

Banducci has, by far, the dominant liquor business, Endeavour Drinks (whose core is Dan Murphy’s), in his portfolio and it continues to perform solidly, with a 3.8 per cent increase in both total and comparable stores sales. It notched up $2 billion in sales for the quarter.

With the hotels business, which increased sales by 4.1 per cent, it provides a steady and solid core of sales and earnings while Banducci continues to focus on the competitiveness of his supermarkets and the attempt to salvage Big W.