Cost-of-living pressures will see more consumers gravitate towards lower priced grocery items this year, providing a boost for discount supermarket Aldi over rivals Coles (COL) and Woolworths (WOW).

That's the findings of a new report by UBS, which predicts both Coles and Woolworths will lose market share to Aldi, with Coles expected to suffer the most.

Shopping trolleys

Discount supermarket Aldi has been gaining market share against its rivals. Picture: AP

It says Aldi - which was hit by supply chain disruptions and a shift to online spending during the pandemic - will regain some of the market share as these headwinds blow over.

“Cost of living pressures [are] another catalyst for market share gains for Aldi. More of this is expected to come from Coles and Woolworths as sales to the Metcash supplied independents remain somewhat resilient," UBS retail analysts Shaun Cousins and Jarrod Chisholm said in the report.

Morningstar director of equity research Johannes Faul is less pessimistic, but does see a risk that Coles and Woolworths could lose grocery market share this year.

“Looking at the UK, where Lidl and Aldi are taking market share from the big four supermarkets over there, that clearly points to the possibility here that Aldi will gain market share, though that is not our base case forecast,” Faul said.

Aldi market share

Woolworths’ share of the grocery market was the greatest at 36% in 2021-22, followed by Coles at 28% and 9% for Aldi.

The rest of the grocery market was held by independent supermarkets such as IGA and Foodworks and independent grocery stores.

The arrival of overseas players


Competition in the Australian supermarket sector has increased over the past decade, with Aldi steadily gaining market share and the arrival of membership-only retailer Costco in 2009. 

However Faul says Costco remains a relatively small player.

“Costco holds about 1% of the grocery market, compared to Aldi's 9%, just to give you an indication of how small their market share is,” he says.

In an interview with realcommercial.com.au last year, Costco Warehouse Australia managing director Patrick Noone said the retailer planned to significantly expand its presence in Australia with three new warehouses already in the works.

“So it’s lots of expansion,” Mr Noone said, “it gives us up to 20 buildings in the next five years.”

While Aldi is still rolling out stores around Australia, its pace of expansion has slowed.

Coles vs. Woolworths


According to Faul, Coles’ sales growth has mostly underperformed Woolworths despite its slightly cheaper shelf prices, as measured by Morningstar's comparable basket.

As of Thursday 16 February, Woolworths was trading at a 38% premium to Morningstar's fair value estimate of $26.50.

Coles was trading at a 36% premium to its valuation of $13.60.

Faul says investors are likely to demand higher dividends from the supermarkets as bond yields rise.

“In the low interest rate environment, the most reliable dividend stocks in the retail sector have tended to trade at a premium," he says.

"However, rising bond yields could prompt investors to reconsider and demand higher dividend yields from defensive consumer staples stocks like Coles, Endeavour, and Woolworths."

Margins will be also key focus, Faul says, when both Coles and Woolworths hand down their earnings next week.

"Higher food prices are likely to drive first-half fiscal 2023 Australian supermarkets sales growth despite post-pandemic volumes normalising and customers shifting to cheaper
alternatives," Faul says.

“The market could be overestimating the positive impact of food price inflation on supermarket earnings.

"We forecast Coles’ and Woolworths’ cost of doing business to increase by more than sales—mostly due to higher wages—and constrain EBIT margins."

However, UBS sees some support for sales revenue at Coles and Woolworths coming from greater population growth and overseas students.

“Looking forward, [supermarket] volumes are to be supported by a return of population growth (immigration, overseas students, backpackers) and the rising cost of living that is expected to drive a shift from out-of-home to at-home consumption,” said Cousins and Chisholm.