Woolworths Limited (ASX: WOW) is Australia's largest retailer and the undisputed king of Australian supermarkets. However, the resignation of CEO Grant O'Brien, increased competition and recent sales downgrades have made many wonder whether it can fend off its rejuvenated competitors and regain its winning ways.
Since hitting an all-time high of $38.92 in May last year, Woolworths' share price has steadily declined as sales have slowed and concerns have grown around Woolworths' ability to retain market share against new foreign entrants, Aldi and Costco. In the same period, Wesfarmers Ltd's (ASX: WES) Coles has grown sales and gained market share (at the expense of Woolworths), indicating that "the fresh food people" at Woolworths may have become stale.
The challenge for Woolworths' new management team is to rekindle sale growth by competing against the discounters and winning back market share from Coles. Although recent analyst downgrades suggest Woolworths may be heading the way of Metcash Ltd (ASX: MTS), the owner of the Independent Grocers of Australia chain (IGA), which recently announced a profit downgrade, I believe Woolworths is one company that can fight the battle for market share and come out on top.
A quality business
Woolworths is the biggest supermarket in the southern hemisphere and controls a whopping 39% of the Australian food and liquor market. Despite Aldi and Costco being industry heavyweights in their respective countries — the latter is the second largest supermarket in the world — Woolworths' advantage over all entrants into Australia is its established supply chain and long-term pricing power over local suppliers. This is something that Aldi and Costco won't be able to achieve in the short-term, giving Woolworths a large enough 'moat' to withstand imminent price pressure by pushing down on margins to return to sales growth.
Unlike Aldi and Costco, which focus on private label sales, Woolworths has a large selection of brands, suggesting that once it fights back on price, its sheer selection of products will allow shoppers to create a one-stop shopping experience. This should raise total transaction values (TTVs) across its supermarket business and see it make up ground in sales growth.
A turnaround strategy
Accordingly, for Woolworths to make a successful turnaround to sales growth, it will need to fight back on price, not simply product differentiation. Following a recent shop at my local Woolworths, it is evident this has already begun, with sales visible in every corner of the store to lift average TTVs.
Whilst its margins will face compression as a result of deeper discounting, in my mind, this is positive for Woolworths as brand loyalty and shopper numbers should subsequently increase.
Foolish takeaway
Despite being a high quality business that has flourished on years of top-line sales growth and industry-leading margins, Woolworths is operating in an environment that is undergoing significant structural change in Australia. In the short-term, Woolworths will face margin compression, making earnings volatile. This is likely to be reflected by weaker share prices in the short-term, making me weary of buying the stock today.
However, Woolworths most definitely deserves a spot on your watch list as further falls in share price would, in my opinion, present a fantastic long-term buy opportunity for Woolworths.
