Wesfarmers Ltd, which owns Coles supermarkets, dominates the fresh food grocery market in Australia together with Woolworths with a market share of around 70%. However, results have been a bit of a mixed bag over the last few years with the company now reporting a net profit after tax up 1.2% year-on-year of $ 1.4 billion, as shown recently with sales growth and a better market share for the 2016 half year. In contrast, Woolworths has had strategy issues with its home improvement business attributing to a loss of $ 1.8 billion to its exit from the Masters business. However, both companies have said that they are focusing on price deflation, cost reduction and price cuts as essential parts of business strategies.
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Financial Performance (Source: Company Reports)
The company expects market conditions to continue to be highly competitive and consumers to remain sensitive to prices and will therefore largely to be focused on improving the productivity of supply chains by reducing costs. The company hopes that this will help them to achieve even lower prices. However, in an industry with thin profit margins, intense competition is associated with high risk. If sales do not achieve expectations, companies have very limited scope to slash prices because of the already low profit margins. Consequently, it becomes more and more difficult to a fixed cost, such as store rent and maintenance expenses and the probability of losing money is high. To some extent, new entrant Aldi has created problems for the retail giants by grabbing 11% market share since it came into the market in 2002 and has fully leveraged its streamlined and cost efficient supply chain. It is also a global player with a significant presence. Even other European retailers such as the German business LIDL are eyeing the Australian market. Other names being suggested are Netto of Holland and Tesco of the UK. Traditionally, Coles has defended rivals by using its large economies of scale to deliver cheaper products to customers and sometimes to use products as loss leaders to force smaller competitors out of the business. In the past, they have been able to maintain market share and eventually maximise profitability. It is likely that the company might continue to lose market share, unless it dramatically changes the strategies and find new methods of innovation.
Moreover, the company has reported non-cash write-down of between $ 1.1 billion and $ 1.3 billion in valuation of the discount target superstore segment as well as further non-cash impairments of between $ 600 million and $ 850 million in the valuation of the Curragh coal business. However, investors know that conditions for the coal business have been difficult and substantial price swings in the future can produce an upside. Nonetheless, full-year profits at the Coles supermarkets owner will take a huge hit post the last month’s warning to investors for the $2.3 billion of impairments and restructuring costs with regard to its struggling Target chain and coal mines.
Recently, it has also been outlined that Wesfarmers’ push into the British hardware and home improvement sector could cost $4 billion to the shareholders in the Perth-based conglomerate post Brexit. Primarily, the situation will worsen up if Wesfarmers sticks with its plans to restructure and reposition Homebase over the next five years. Citi has in fact said that Homebase that will account for an estimated 4% of Wesfarmers' revenue in FY18, will witness softness in demand backdrop as population growth and the economy slow in the U.K. Further, a 10% fall in sales at Homebase will have immense repercussions on the business leading to a 1.6% drop in group EBIT. There has also been an indication of probable dividend cuts for Wesfarmers, as outlined by Morgan Stanley, looking at the intense competitive pressure on retail business from Woolworths and international players such as Aldi. The stock has plunged 4.76% in the last one month (as at June 27, 2016).
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