Consumer staples: looking beyond Coles and Woolies
Why investors seeking defensive assets might do better looking past the big-name supermarkets and to this liquor store giant.
Mentioned: Coles Group Ltd (COL), Endeavour Group Ltd (EDV), JB Hi Fi Ltd (JBH), Myer Holdings Ltd (MYR), Woolworths Group Ltd (WOW)
When on the hunt for defensive retailers, two names that often crop up are Woolworths (WOW) and Coles (COL), but at current prices, investors may be better served looking further afield to find value in consumer staples.
As Australia’s two major supermarket retailers, Woolworths and Coles have in the past proved attractive to investors looking for secure access to a segment of the retail market considered more defensive than discretionary consumer stocks.
Many grocery staples are by their nature necessities, meaning buyers are more likely to continue purchasing them even when money is tight—unlike the fashion or tech products offered by other big ASX retailers like Myer (MYR) or JB Hi-Fi (JBH).
But in accessing the security of a consumer staples stock, investors may find themselves paying a premium, particularly in times of high demand. That has been the case recently as retail spending pulled back and defensive dividend-delivering retailers became more attractive.
Looking at the price of Woolworths and Coles in recent months, both stocks have continued to trade well above levels Morningstar considers fairly valued.
Further, mounting margin pressures and the threat of incoming competitor Aldi have hampered Morningstar’s outlook for both of the nation’s supermarket giants.
Morningstar is forecasting earnings margins for both companies to begin weakening in the second half of fiscal 2023, with this trend expected to continue in fiscal 2024.
Currently, both stocks are classified as 1-star by Morningstar, meaning they’re screening as overvalued based on analysis of their respective fair value estimates and uncertainty ratings.
But that doesn’t mean investors have to risk paying a premium if they’re seeking consumer staples stocks.
Liquor giant offers ‘best value’
Morningstar analyst Johannes Faul says liquor and hospitality group Endeavour Group (EDV), which was spun off from Woolworths in 2021, may provide an enticing option in the sector.
Endeavour operates Dan Murphy's and BWS and holds a portfolio of licensed hotels and pubs.
Shares in the company recently moved back into three-star territory, meaning Morningstar ranks the stock as “fairly-valued”. But even when the group was trading as slightly overvalued earlier this year, Faul said the group offered the most appealing value to investors seeking exposure to staples retailing.
“When we're talking about consumer staples, Endeavor is the most attractively valued one at the moment from an investor standpoint,” he says.
“It offers dividend yield that's comparable with Coles and Woolies and has strong competitive advantages compared to its peers.”
The group operates well-known liquor retailers Dan Murphy's and BWS and holds Australia’s largest portfolio of licensed hotels and pubs. Endeavour is the dominant player in the liquor space, commanding around half of the addressable market, a position that Faul says gives it advantages over its peers.
Endeavor is the only consumer staples stock in Morningstar’s ASX coverage universe to hold a 'wide-moat' ranking, meaning it should keep competitors at bay for at least two decades.
Faul says Endeavor’s wide-moat rating is a rarity in the Australian retail sector and is derived from the group’s defensive liquor and gambling operations.
“Endeavour's liquor sales are also much more profitable than closest competitor Coles. We forecast Endeavour's industry-leading operating profit margins to be maintainably higher because of the group's greater operating leverage and sales productivity,” he says.
That isn’t to say the group is entirely immune to economic cycles. In Endeavor’s most recent quarterly report, Faul noted declining pub sales, likely brought on by the rising cost of living.
“As consumers dine out less because of pressures on their household budgets and Endeavour's pubs business cycles a post-reopening period, we expect sales growth to moderate further,” he says.
Also of note in the recent quarter, the company’s liquor sales growth lost out to Coles, coming in at 1% and 3%, respectively. Faul attributes the slower growth to an intentional decision by management to lose out in online sales to better protect profits.
“Endeavour's management stated it focussed on maintaining profitable sales, which we interpret as taking the calculated risk of losing some market share to protect its EBIT margins.”
But with a comparable dividend to its peers, a defensible brick-and-mortar earnings base and the competitive advantages that underpin its wide-moat ranking, Faul says Endeavor remains one of the best value options for investors seeking a consumer staples stock.
Shares in Endeavour are trading in line with Morningstar’s fair value estimate of $6.40.