A hearty third quarter sales result for Woolworths will be accompanied by the heartburn of falling food inflation. Consumers are belt-tightening as higher interest rates bite into household budgets.
Australian Food. Average prices in 3Q23 added 5.8% to sales which totalled growth of 6.9% in WOW’s supermarkets. Comparable store sales growth hit 6.6% in the quarter, narrowly edging COL.
WOW noted a 9.1% increase in sales of own brand and exclusive brand products. Both pantry and chilled goods surged over 20% indicating a reversion to home-cooked meals, a similar reaction as when the pandemic initially hit in 2020.
A faster pace of online sales and new store growth over the last four years explains the superior sales growth of WOW compared to COL. But these sources have additional costs, so the comparison slightly flatters WOW.
The biggest factor in the retail industry is the impact of inflation which appears to have peaked in the December 2022 quarter. In 3Q23, WOW’s food inflation of 5.8% was 190bp lower than 2Q23 and we see this trend continuing into FY24f. The RBA’s latest 25bp interest rate increase will certainly squeeze many households, notwithstanding what the Government’s Budget might contain in terms of relief for voters. The RBA’s forecast is for inflation to be 4.5% in 2023.
Soft commodity prices are falling helping to alleviate weekly shopping bills over the next 6-12 months.
Pushing back against this is the on-going higher cost of labour and supply chain costs.
With the announced increase in the price of tobacco by the Government, sales in this category may continue to fall. We estimate that tobacco contributes about 4-5% of supermarket sales.
BIG W reported comparable sales growth of 5.5% in 3Q23. This is a significant improvement over the last four years, but as with most retailers, sales growth should ease in the near term. A steady state rate of growth is more likely to be around 1-2% pa.
Investment View
At a PE ratio of 27x, WOW is expensive. We downgrade our recommendation from Buy to Hold based on inflation having peaked which will lead to lower sales growth over the next 12 months. FY23f earnings are likely to be strong but should moderate in FY24f. Wage increases will place pressure on margins.
Risks to Investment View
Competition could increase and negatively impact WOW’s profit margins. Inflation may be less than predicted, or raw material price increases might not be sustained
Recommendation
We have lowered our recommendation to Hold from Buy.
