Coles
Coles was purchased by Wesfarmers during the 2007/08 financial year (November 07). After the purchase Wesfarmers invested heavily in turning the Coles business around. Major changes were made to the senior management team, stores were refurbished, changes in range and pricing were rolled out.
The table below highlights that EBIT, during the 10 year ownership period, increased from 2.8% to 3.8%.
Source: Wesfarmers 2018 annual report, 2008 annual report
The financial results during the 10 year ownership period were strong. March 2018 the Wesfarmers board announced the plan to demerge the Coles supermarket business from the Wesfarmers conglomerate. Wesfarmers could retain a minority shareholding of up to 20%. Recent reports suggest Wesfarmers will maintain a 15% shareholding and the process will complete in November 2018. Personally, I believe the Wesfarmer’s board is demerging Coles due to recent decreasing profits / ROI at Coles. Simply put, the Wesfarmers board believes they can make more money investing in another business. In the 2018 Wesfarmers annual report Coles EBIT was $1,500M, -6.8%. So what factor/s have decreased Coles profit / ROI?
Source: Investsmart
This chart highlights that since the high of 2016 Coles has struggled to grow profit (EBIT).
GFC (Global Financial Crisis)
During the GFC some predicted that Coles and Woolworths would be the worst hit. The reasoning was consumers would switch to hard discounters, such as Aldi, for cheaper prices. It was also predicted that consumers would not pay a premium for branded products and would switch to private label. Again, this would hurt Coles and Woolworths that have a far greater percentage of total sales in branded products vs Aldi with its pre-dominantly private label offer.
10 years ago, the GFC (global financial crisis) hit global finance markets. A major event was on the 15th September 2008 when Lehmann Brothers filed for bankruptcy in the US (Wikipedia). This economic event did lead to financial distress in some countries, but “the effect of the crisis on Australia has been considerably less than in many other countries” (ABS). The Australian government did support the retail industry in general by making cash payments to Australians. Treasurer Swan announced in February 2009 a $42B stimulus package, including one off cash payments to Australians, to stimulate retail sales (Wikipedia).
Coles and Woolworths Margin post GFC
The following chart highlights that Coles and Woolworths were able to increase their margins post GFC. This would suggest that the GFC did not have an impact on Coles and Woolworths. As discussed earlier this may be, in part, due to the GFC not having a major impact on the Australian economy. Similarly, other large Australian companies, such as the big 4 banks and the major miners, were not impacted in the short term.
Source: Motley Fool
So, the GFC did not have a major impact on Coles business results.
Aldi
The following chart highlights that Aldi was able to continue to grow their sales and share post GFC. 2008 was a good year (+1.2% share points) during the GFC. A major factor in the sales and share growth was Aldi opening more stores in Australia.
Source: Nielsen
In 2014 Aldi Australia announced plans to enter the South Australian (SA) and Western Australian (WA) retail markets. The first Aldi SA store opened in February 2016. The first Aldi WA store opened in June 2016. Today, Aldi Australia has over 500 stores throughout mainland Australia. Aldi Australia is also in the process of refurbishing all their older stores by 2020.
Personally, I believe the continued expansion of Aldi, including into SA and WA, has been a factor in the Wesfarmers board decision to demerge Coles. Simply put Coles has lowered prices to compete with Aldi (and others) and this has led to decreasing profit / ROI recently. Coles has experienced over 8 consecutive years of price deflation. This is possibly why Coles current CEO, John Durkan, announced a new differentiation strategy (‘Fresh Tomorrow’) at the strategy day in June 2018. The new strategy will focus on differentiation in fresh and digital / e-commerce. These are 2 areas where Aldi traditionally underperforms.
Woolworths
The Woolworths board made a major investment decision during the post GFC period, to launch Masters Home Improvement (Wikipedia). The first store opened in 2011 and they exited the business in 2016. This investment did limit the amount of money Woolworths Australian supermarkets were able to invest their business.
The following table highlights that Woolworths EBIT has decreased during the last 10 years. Their EBIT % is still greater than Coles. In the 2018 annual report Australian Food (excluding liquor) EBIT was $1,757M, +9.6%. So recently Woolworths profit has been increasing whilst Coles has been decreasing.
Source: Woolworths 2018 annual report, 2008 annual report
The following chart and table highlights that after exiting the Masters business Woolworths Food EBIT did decrease i.e. they invested heavily in price, stores and supply chain to grow their sales.
Source: Business Insider
Source: Woolworths 2018 annual report, 2017 annual report, 2016 annual report
These financial results highlight that Woolworths has been able to lower prices / margin and grow sales recently. After exiting Masters, the Woolworths board have been able to invest cash into the Woolworths Australian supermarket business to grow sales … just like Wesfarmers did after buying Coles in 2007.
Personally, I believe the recent aggressive investments of Woolworths recently has had the biggest impact on Coles. Both retailers offer a similar full service supermarket so they are competing for the same customer. Woolworths now has the cash to invest back into their pricing and stores to compete with Coles. In Woolworths 2018 annual report it noted that in the last 2 years they have refurbished 1/3 of their stores and have lowered prices on over 4,800 SKUs on the Dropped & Always program. Woolworths are also investing heavily into their supply chain. For example, the Melbourne South Regional (MSR) DC at a cost of $560M+ is “the largest and most technologically advanced in the southern hemisphere” (AFR).
Summation
The Wesfarmers board are demerging the Coles supermarket business due to decreasing profit / ROI. During their 10 year ownership of Coles they were able to turn the business around and post some strong financial results.
Since 2016 (post Masters) Woolworths supermarkets have had the financial resources to invest heavily into their business and this has hurt Coles. For Coles to compete with a resurgent Woolworths would require the Wesfarmers board to make further significant cash investments into Coles. The Wesfarmers board has decided this is not the best use of funds so they will exit the supermarket industry.
Other retailers such as Aldi and Costco offer a different type of shopping experience to Coles. They have had an impact on Coles due to their competitive pricing. Looking forward the Wesfarmers board is probably also concerned that more multi-national retailers (Amazon, Kaufland etc) will increase the level of competition in the Australian supermarket and possibly lower prices.
Personally, I believe the main reason Wesfarmers is demerging Coles is due to increasing competition decreasing profit / ROI. Recently Woolworths has hurt Coles and going forward it could be Woolworths or a multi national retailer like Aldi or Amazon …
The information provided in this blog post was general in nature. If you require more information I offer a free initial consultation by completing a contact us form.
Thank you,
Tim Bowen
