Apologies if it's been posted.
Woolworths’ struggles against interloper Aldi just beginningMay 12, 2016 1:59pm
Roger MontgomeryHerald Sun
The primary cause of Woolworths’ woes is the arrival of Aldi.
AS A consumer I love it when Woolies offers lower prices.
If I was still an investor in the shares of the company, I’d be much less sanguine about lower prices!
Since Montgomery sold its Woolworths shares in November 2014 — above $30 — the stock has been in decline.
At around $21 today, down some 30 per cent from where we sold, the share price could represent an opportunity to make a lot of money or an opportunity to lose a great deal more.
To help resolve the dilemma, it’s worth briefly understanding how Woolies arrived at this unenviable position.
The primary cause of Woolworths’ woes is the arrival of Aldi.
A further contributor however is corporate governance, although I make the point that there is only so much even the best oarsman can do if his boat has a leak.
Aldi makes a profit globally on a 2.5 per cent margin for earnings before interest and tax.
Not long ago Woolworths was reporting 8 per cent margins.
Aldi can confidently operate and expand on 2.5 per cent margins because it is simply operating a more efficient business.
When Aldi enters a new country, it only does so if the salaries of the employees in that country are very high.
Why?
Because it gives the company an immediate operating advantage.
That’s the only way its model works.
You see, an Aldi supermarket might have three employees in a store of the same footprint that Woolies requires 30 people.
Aldi can operate with less staff because its promise is to offer the best price, not the biggest range.
Where Woolies might have 30 tomato sauce products, Aldi has just one.
Aldi can operate and expand on 2.5 per cent margins.
That means it has better buying power for that tomato sauce than Woolies and Coles even though the incumbents have enjoyed 80 per cent market share and Aldi just 10 per cent.
With fewer individual products needing replenishing on the shelves, fewer staff are required to operate the business.
Aldi doesn’t enter a country unless it displays high average gross domestic product (where customers care about quality), and high wages.
Ideally it also likes to find territories where there isn’t already a hard discounter established (In Australia, all three criteria were met). This is the point at which Aldi rolls out its 20-year plan.
Once it establishes a presence it brings its products from existing, more mature markets.
Aldi is a debt-averse business and so it was always going to grow slowly because it needs to buy sites and build stores.
When it gets to 350 stores, and about $3.5 billion in sales then the company is in a position to source its products locally. It is then the biggest purchaser of the products it is interested in.
It then buys local and at a cheaper price than Coles and Woolies.
It can also demand the recipe it wants and it starts hitting the taste and quality expectations Australian wants.
It can also demand its own packaging with the special barcodes it requires to allow the cashiers to scan the products much, much faster, thus sending more customers through the turnstiles with fewer staff!
But this is not an article about Aldi, It’s about Woolworths.
What can Woolworths do? To begin, they are now playing by Aldi’s rules.
Their first return volley was to “invest in lower prices”.
This is a euphemism for cutting prices (and cutting profits for shareholders, by the way).
Woolies is discovering that it’s simply not working and they have now reported four quarters of negative same-store sales growth.
Some analysts believe that Woolies will recoup the lost margin from suppliers because the volume has gone up and that it will cut staff costs.
But customers have long complained that there aren’t enough staff in the supermarkets so if staff are cut, presumably customer satisfaction will decline further.
A further issue is that whenever Woolies cuts its prices, the others, including Aldi respond meaning it will have to continue “investing” in lower prices.
Nowhere in the world have incumbents survived the entry of Aldi with their margins intact.
Woolies will survive, but Aldi is here to stay and Woolies must be a smaller business (spinning off Big W, exiting Masters, etc) and/or report lower margins and profits.
ROGER MONTGOMERY IS MONTGOMERY INVESTMENT MANAGEMENT CHIEF INVESTMENT OFFICER
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