This household ASX name just got a moat upgrade
Woolies faces intense competition from Coles but has strong advantages in its favour.
Woolworths (ASX: WOW) has long been Australia’s largest supermarket. While we think impressive market share gains of discounter Aldi have come to an end, we expect the competitive tension to intensify in the online channel, particularly between the Coles-Ocado partnership and Woolworths.
Amazon Australia already sells pantry items and the launch of Amazon Fresh is probable in the coming years, but we expect Amazon to remain a marginal player in Australian food for the forseeable future. Nevertheless, Woolworths is a strong business, with competitive advantages stemming from its leading market share, resulting in low cost of doing business, high bargaining power and a vast store network.
We expect these attributes to enable Woolworths to maintain its market share and protect operating margins.
Outperforming Coles on key metrics
In Australian supermarkets, Woolworths outperforms Coles (ASX: COL) on key metrics, including operating margins, returns on invested capital, and market share. Woolworths is also the owner-operator of its fast-growing online channel, while Coles partially outsources picking-and-packing to Ocado.
Woolworths’ dominant scale allows it to leverage distribution, administration, and marketing costs in a way that smaller competitors cannot. From this alone, we estimate Woolworths has a structural operating margin advantage over its closest competitor Coles.
Discounter Aldi’s Australian business is mature and we don’t forecast it significantly increasing market share. We expect warehouse Costco, expanding from a low base, to remain a minor player. German hypermarket Kaufland scrapped its plans to enter Australia in 2020.
Well-positioned in fast growing online channel
Woolworths’ store network is a fulfilment channel for the rapidly growing online channel. We believe its greater store network likely translates to average lower fulfilment costs from its stores. Woolworths gained market share in online in recent years, which we estimate at over 60%.
Grocery e-commerce is difficult to break into for online pure-plays. While Amazon is rapidly increasing its share of discretionary retailing, we think it’s unlikely Amazon Fresh will be successful in Australia. For instance, after operating in Germany for seven years, Amazon Fresh pulled the pin in 2024.
Food e-commerce is also challenging for discounters like Aldi, as online fulfilment costs endanger the low-cost business model. Australian independent grocers are also unlikely to effectively compete online, due to higher average shelf prices and comparatively much smaller scale.
Market share and margins look strong
We estimate Woolworths had 36% market share in 2024. This is roughly 30% more sales and stores than the second-largest supermarket in Australia, Coles, which commands 28% market share.
In the seven years to fiscal 2024, Woolworths has maintained an average adjusted EBIT margins of 5.6% in Australian food, about 70 basis points ahead of Coles while also expanding market share. Woolworths’ superior operating margins over Coles and other competitors provide Woolworths with extra protection to defend its market dominance by price cutting.
Woolworths Australian Food also generates higher returns on capital than Coles on our estimates, although returns are diluted at group level by less profitable business units. Two of Woolworths’ three smaller business units, New Zealand Food and W Living, are in a cyclical rut.
Even without a recovery in these businesses, we believe they are too small to detract from the strength of the core Australian supermarkets segment.
Change to moat rating and Fair Value
We upgrade our moat rating on Woolworths to wide from narrow as Woolworths’ cost advantages are more durable than previously thought, supported by the industry’s market structure. The widening of Woolworths’ moat boosts our Fair Value estimate by 7% to AUD 30.50.
We do not expect Woolworths to widen its margins towards similar levels it had enjoyed before 2016, as the Australian supermarket sector has structurally changed with the reintroduction of the discount channel. We expect major supermarket chains to pass of efficiency gains to consumers through price cuts instead of expanding markets and potentially losing market share.
As a result, we expect Woolworths to successfully defend its market share in food retailing at around 36% in the long term against key competitor Coles and other grocers.
