Beleaguered supermarket retailer Woolworths Limited (ASX: WOW) has offered a number of clues as to why next year's earnings and profit are likely to be lower than this year.
Profits for the 2015 financial year fell 12.5% to $2.15 billion compared to last year, but in line with last year's results once one-off items such as impairments were taken out.
Here're the two reasons clearly spelled out by Woolworths' management:
"While we enjoy significant competitive advantages, a more competitive environment will result in lower margins as we invest to improve all aspects of the customer offer, notwithstanding gathering momentum in operating efficiencies".
Yes, Woolworths is lowering its margins as it drops prices to compete with rivals Coles –owned by Wesfarmers Ltd (ASX: WES), Aldi, and IGA-backed Metcash Limited (ASX: MTS). Lower margins will most likely lead to lower profits unless revenues increase substantially – but that's unlikely to happen. Woolies already earns $61 billion in revenues each year – even growing in low single digits is tough.
Here's the second reason.
"FY16 will bear the impact of our decisive response to the competitive environment to meet our value commitment to customers with our investments in price, service and experience exceeding cost reductions in this period."
Clearly, the retailer expects to see higher costs and above the level of cost cuts. That will again reduce margins, lowering profit.
In fact, lower margins and a more competitive Woolworths are exactly what is needed to drive higher growth and protect market share. Without that, Woolworths could end up in Metcash's position.
One indicator to watch is sales per square metre. As you can see from the chart below, Woolworths sales per square meter of supermarket space is dropping, while Coles' continues to rise.
Foolish takeaway
Don't be surprised if 2016 is a disappointing year for the retailing giant. Over the long-term, Woolworths should be able to return to a resemblance of its former self.
I'll still be holding onto my Woolworths shares. The company offers a fully franked dividend of 5% at today's price of $27.47, which grosses up to 7.2% when you consider franking credits. The dividend is likely to be at least maintained until sustainable growth is reached.
