The big supermarket operators like Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) sometimes seem like a natural place to invest. They are strong businesses, pay reliable dividends, and have at least some competitive advantages.
Still I'm not a buyer today, for 2 primary reasons:
- Competition
Woolworths, Coles, Aldi, Metcash Limited (ASX: MTS), plus some other operators like Lidl and Costco are competing for a pie that is growing relatively slowly. Plus, Australia has historically had higher grocery margins compared to some international markets, so pricing pressure on margins will likely remain high – potentially hurting profits.
- Limited growth
While certain categories of food such as gluten-free or precooked might be growing rapidly, it does not appear that the market for supermarket products is growing rapidly. So, the size of the 'pie' for which these stores compete is not becoming much larger. Additionally, while volumes might be rising, the % of profit earned on these sales could be falling, due to the above competitive pressures.
- Divestments
Woolworths in particular is talking about divesting its petrol stations and possibly also its Dan Murphy's liquor business. While these transactions may unlock value for shareholders, it will also result in selling a business that's contributing to earnings and it is unclear what new prospects could replace these.
Still, if I'm wary of investing in the supermarkets, I'm even more wary of investing in companies that sell their products in a supermarket. Low cost own-brand products are being rolled out in every category from snacks to paracetamol. Which is great, until you look at home brand paracetamol that costs 1/8th the price of Panadol and think about what could happen to the profits of the company that makes Panadol.
