Will Coles be safe against low-cost grocery invaders?

The sell-off in Woolworths could be bad news for its archrival.

For at least a generation, the Australian grocery sector has been dominated by two companies: Coles and Woolworths. Suddenly that duopoly — which was never great for shoppers or suppliers — is challenging investors too.

This week’s surprise departure of Woolworths CEO Grant O’Brien (who has left no obvious successor) came just days after it was reported German powerhouse low-cost grocer Lidl is to join Aldi in the local market.

In a predictable fallout stockbrokers are now falling over themselves to put “sell” notes on Woolworths ... even though it is down more than 20 per cent in ­recent months. Indeed among leading stockbrokers only one — David Errington at BOA Merrill Lynch — has a “buy” recommendation.

Meanwhile at Coles — represented on the stockmarket by the conglomerate Wesfarmers — the stock price has been fairly steady and brokers are still broadly supportive.

The crumbling of what was a ring-fenced money-making ­machine has already had its first victim in the shocking collapse of Metcash — the company behind IGA, which has lost two thirds of its share price in recent times and is sandwiched between the supermarkets and up-market “providores” that now dot many suburbs.

But for most investors the question of concern is the future of Coles and Woolworths as listed stocks in the face of brutal low-cost competition, which offers dramatically lower prices and the inevitable acceleration of a “price war” if Aldi ultimately goes head-to-head with Lidl in our market.

Just in case you missed the overseas story: the Aldi and Lidl price war in Britain completely hobbled their equivalents to Coles and Woolworths, which were Tesco and Sainsbury’s.

The vulnerability of the British groups surprised even the smartest investors including Warren Buffett who lost $US444 million on a Tesco investment (Buffett finally joined the Australian market this week with a 4 per cent stake in insurer IAG).

Now while our local brokers seem to think that Coles will somehow be immune from this low-cost assault it is interesting that others are not as sanguine: the rating agency Moody’s has ­issued a note warning there will be negative credit implications for both Coles and Woolworths as Lidl joins Aldi in Australia.

Certainly, Woolworths has a plethora of problems from ­Masters Hardware to Big W to the current difficulties faced in its supermarkets where it is being beaten on a like-for-like basis by Coles — this is what led to O’Brien’s demise this week.

But Coles — or at least the listed enterprise Wesfarmers — has much to lose. The issue for Richard Goyder and his team at Wesfarmers is they can hardly be held in higher esteem by institutional investors. Indeed those same investors have been very forgiving about the residual coal business at Wesfarmers, which is an unresolved problem.

What’s more, anyone who has watched the fortunes of Coles and Woolworths wax and wane over recent decades would realise the remarkable recovery of Coles between 2009 and 2014 cannot be repeated in the months ahead.

In contrast, looking at Woolworths it is in deep crisis just now — but even in these dark days it can make more than $2 billion a year in profit.

Moreover, profit margins at Woolworths are solidly higher than Coles and that means in the razor competitive world of supermarkets Woolworths under a new management regime has the capacity to fight back on price in a fashion that is not apparent at Coles.

In Britain, both Sainsbury’s and Tesco were caught napping by the compelling power of the low cost German retailers — the Australian incumbents are by no means naive to the threat. The surprise exit of O’Brien at Woolworths this week proves that point clearly.

From an investment point of view the issue is clear. You can’t invest in Aldi or Lidl — they are both private German companies. It comes down as always to looking at the two incumbents and making a call — just now it looks like Woolworths has the potential to recover, just like Coles had back in 2009 when the “Wesfarmers” turnaround began. Coles on the other hand will need to man the barricades.

It’s taken some fortitude for the lone ranger Errington to put a “buy” call on Woolworths. In a year’s time he may be proved correct. You have to wonder if such courage is now needed within the ranks of brokers who have seen no need to look a lot harder at the future for Coles.