Another big ASX name reports fiscal 2024 earnings on Wednesday as food retailing giant Woolworths (ASX: WOW) steps up to the plate.

Still Australia’s dominant supermarket

Morningstar's Johannes Faul estimates that Woolies still enjoys over a third market share in Australia’s food retail market, with sales around 25% higher than arch-rival Coles and three times as much market share than third-place Aldi.

Woolworth’s scale advantages allow it to leverage distribution, administrative and marketing costs across a far larger base of sales and drive a harder bargain with suppliers. These advantages have long allowed it to achieve industry leading profit margins, and they underpin the firm’s Narrow Moat rating.

To learn more about why Morningstar awarded Woolworths a moat but not Coles, read this article on 3 no moat companies that might surprise you.

What are we looking for in Woolworths earnings?

Ahead of Woolworths’ results on Wednesday, Faul earmarked three things he’ll be keeping an especially close eye on.

  • Profit margins in their Australian food business: Faul expects these to be down slightly, with higher staffing costs due to wage inflation being the main drag.

  • Food price inflation in Australia: This provided a tailwind to sales and earnings in previous years. This looks set to be less of a factor this year, but Faul is interested to see if it is still underpinning some sales growth.

  • Trading in early fiscal 2025: Woolworths will likely shed some light on how things have been going in the first 8 weeks of the new financial year. Lower inflation could detract from sales, but Faul thinks consumers may be leaning more towards home cooked meals than restaurant dining. Tax cuts could also drive some extra demand for retailers in general.

Where is Woolies valuation sitting before earnings?

At a current price of over $35 per share, Woolworths is trading considerably above Faul’s Fair Value estimate of $27.50 per share.

Faul's valuation assumes that Woolworths does not widen its profit margins towards the levels it enjoyed before 2016. He thinks the Australian supermarket sector has structurally changed since then with the reintroduction of the discount channel. Aldi has expanded aggressively to take share here, while Amazon Fresh looms as a potential long-term threat.

Faul expects supermarkets to compete by passing on efficiency gains or cost savings to consumers through price cuts, instead of expanding operating margins and potentially losing share. He expects Woolworths to successfully defend its market share in food retailing, but thinks it caps its upside when it comes to operating margins.

Given the large premium to Morningstar’s estimate of Fair Value, Woolworths shares currently command a one-star Morningstar rating.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.