Lex Hall: Hi, I'm Lex Hall, and welcome to the Morningstar series, "Ask the Expert." Today, I'm joined by senior equity analyst Johannes Faul and we are going to talk about two Australian household names, supermarket giants, Woolworths and Coles.

Johannes, thanks for joining us.

Johannes Faul: Thanks for having me, Lex.

Hall: Now, Woolworths has just announced the $1.7 billion share buyback. What prompted the company to do this and what does it mean for shareholders?

Faul: What Woolies has been trying to do and has now completed is the sale of its petrol business. So, there was a false start about two years ago and now, finally, they have successfully completed that sale and announced it yesterday on the 1st of April, which means they have got $1.7 billion coming in the door. So, that's the proceeds from the sale. This money, this cash, is being redistributed to the shareholders. And you know, the vehicle to do so Woolies chose the off-market share buyback. So, it has various implications for shareholders. So, it really depends on the shareholders' marginal tax rate, but then also obviously where at which price the shareholders acquired Woolies shares. So, there's a lot of moving parts and we really suggest shareholders do consult their tax adviser and also their financial adviser for advice on what to do and whether not to…

Hall: And what can we say about the timing of this? Is there something significant in that that caught your eye?

Faul: In terms of why they have done this now?

Hall: Why now?

Faul: Yeah. Look, the deal completed yesterday and on the same day they announced the share buyback. So, it was complete, they have done that. So, that's the share buyback. And I think that's been very well-flagged with the market. Didn't come out of the blue. And put this way, it wasn't a surprise to us. However, with that news Woolworths also announced an update on its discount department store chain Big W, which – you know discount department stores have had headwinds coming their way as have the more upmarket department stores in Australia. And Big W has seen earnings basically go negative.

So, they have been loss making for a few years and this year looks like another loss making year. So, Woolworths did give a bit of guidance on where they see earnings and they can be somewhere in the vicinity of $82 million loss this year, which is really detracting from the strong supermarket business that they have. And in their update the way Woolies is approaching to fix this issue is by rationalising their store network.

So, if you think about the discount department store sector, there's two headwinds facing it. Not only they have the traditional specialty stores, brick-and-mortar stores, out there, but now you have online which is global market really for the products that these department stores sell.

Hall: And speaking of online, let's move on to Coles now. They have signed a deal with British online retailer Ocado. Tell us a bit about that deal and what it means for customers and for shareholders.

Faul: Yeah. You're right, it's a great segue and it basically shows where the consumer is going and where the consumer is migrating to and that's online. So, we've seen Ocado, which as you said, is an online retailer in the UK. So, they have about a percent market share in the UK and they are a pure online play there. But what they also are, they are a service provider and they have their own platform. And they have been selling this platform internationally to market-leading grocers, so either one or two market-leading position number one or number two. In France, it's been Casino, in Sweden it's been ICA I believe; in Canada, they've sold their platform; and most importantly, in the US, they sold their platform to Kroger, which is the largest supermarket chain in the US.

In the case of Coles, they are lagging Woolworths in terms of their investments, their capital spend on their online channel and they wouldn't have, in our mind, the capital to now invest in their own online channel to bring that on par with Woolies. So, the question is now, will they leapfrog Woolworths and what does that mean to earnings. It's hard to tell from that standpoint; what is certain is that Ocado offers a profitable online platform currently and that compares to like a breakeven scenario which Woolworths and Coles will see themselves in.

Look, in a nutshell, looking at those two supermarkets, in terms of where we see value, Coles, we believe, is fairly valued at current prices, maybe touch undervalued, whereas we believe that Woolies is overvalued, and it's valued as a growth stock currently with earnings not really growing that strongly. And so, in the first half of this year we saw earnings growth close to zero, underlying earnings growth.

Hall: All right, Johannes, thanks for your insights.

Faul: Thank you very much, Lex.

Hall: I'm Lex Hall for Morningstar. Thanks for watching.