ASX 200 better buy: Wesfarmers or Woolworths?

Let's see how these ASX stalwarts stack up.

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It's been a wild ride on the ASX this year and no corner of the market has been spared. 

As interest rates rise and inflation soars, consumer-facing businesses, in particular, have been feeling the heat.

While these businesses come in all different shapes and sizes, there are two at the pointy end of the S&P/ASX 200 Index (ASX: XJO) that often draw comparisons: Woolworths Group Ltd (ASX: WOW) and Wesfarmers Ltd (ASX: WES).

Let's see how these two ASX blue-chip shares stack up.

Comparing apples and oranges

Before we dig into which of these ASX stalwarts might be a better buy, let's first set the scene.

Both Wesfarmers and Woolies are conglomerates comprising many different brands. Wesfarmers owns a large and diverse stable of household names, including Bunnings, Kmart, Target, and Officeworks. More recently, it acquired formerly ASX-listed Australian Pharmaceuticals Industries which owns the Priceline network of pharmacy stores across the country.

Woolies, on the other hand, is more concentrated after spinning off its retail drinks and hotels arm last year. Nowadays, an investment in Woolies predominantly has exposure to the eponymous supermarket chain. The group's Australian and New Zealand food segments generated 86% of revenue and nearly all of its earnings in the first half of FY22

So, despite sharing similar roots, various divestments and acquisitions on both parts have seen the two conglomerates' operations drift apart over the years.

The case to put Woolies shares in your shopping trolley

Inflation has stolen the spotlight in recent months as the cost of living heads north and consumers feel the pinch.

Along with eye-watering prices at the petrol bowser, the other category of most concern to consumers is food inflation. 

Just one look at the price of lettuce and it's clear to see food inflation is out in full force. A combination of factors has been driving this, including higher input costs, supply chain issues, floods, and labour shortages.

Rising inflation is leading to higher prices on supermarket shelves as the likes of Woolies and Coles Group Ltd (ASX: COL) pass on cost increases. Meanwhile, demand typically holds steady as consumers shift their spending away from discretionary items, such as clothes and electronics, toward essentials.

What's more, an inflationary environment usually sees budget-conscious consumers turn their backs on dining out in favour of buying food to cook at home. With value being front of mind for shoppers, sales for Woolies' higher-margin homebrand products will likely receive a boost. That said, this could be offset by lower sales for the supermarket's more premium Macro brand, which also attracts juicier margins.

On the whole, rising inflation could be a net benefit for supermarkets like Woolies, which are expected to post robust sales growth this ASX reporting season

Looking out into the longer term, Woolies shares offer a defensive earnings profile due to the non-discretionary nature of groceries. Management has been delivering on its strategy to reinvest in the high-returning core business, demonstrating sound capital allocation to balance shareholder returns and growth.

The case to add Wesfarmers shares to your toolkit

While its supermarket chain makes up the lion's share of Woolies' sales and profits, Wesfarmers' operations are more diverse. Here, the driver is Bunnings, with the beloved home improvement store raking in 52% of group revenue and 70% of group earnings in the first half of FY22

But Wesfarmers also has meaningful contributions from Kmart; Officeworks; Catch; its chemicals, energy, and fertilisers business; its industrial and safety business; and, more recently, a foray into health via its acquisition of API.

This diversification adds to Wesfarmers' resilience while also providing the group with multiple growth levers. Beyond the household names, it has exposure to lithium through the Mt Holland project and also has its sights set on a further multi-billion-dollar push into the health, wellness, and beauty markets.

In my eyes, the beauty of Wesfarmers lies in its portfolio of market-leading brands. The likes of Bunnings, Kmart and Officeworks are top of mind (and hearts) for consumers, making a name for offering the lowest prices and widest ranges. With this strong brand power comes hefty sales, which allows these businesses to continue to reap the benefits of scale. 

These high-quality brands are led by none other than Bunnings, a powerhouse in the Wesfarmers portfolio. In the first half of FY22, Bunnings boasted returns on capital of 79%. The business isn't resting on its laurels either, with plans to further expand in household categories and take a greater share of the commercial market.

So which is the better ASX 200 buy?

Both Woolies and Wesfarmers have a history of market-beating returns and could be worthy of a spot in a diversified portfolio.

So far this year, Woolies shares have come out on top as Wesfarmers' retail arms have been exposed to COVID lockdowns and the health of the Aussie consumer.

While the defensive nature of Woolies shares is attractive, over the long term I'd be leaning towards Wesfarmers for its optionality and exposure to the jewel in its crown, Bunnings.  

Motley Fool contributor Catherine Goh has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended COLESGROUP DEF SET and Wesfarmers Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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