The super-sized sales results recorded during the pandemic are being supplanted by more normal conditions, albeit infused with inflation. Woolworths has ceded ground to Coles, but sales growth will begin to accelerate and will once again lift the PE ratio towards 25x. We have upgraded our recommendation to Buy.
One quarter does not make a trend. Although WOW 1Q23 comparable sales growth of -1.1% was below COL at +2.1%, excluding tobacco where sales have fallen ~15% in the period, the gap narrowed. Lockdowns and the associated COVID costs make short term comparisons between the two supermarket operators problematic. Over a period of three years, the CAGR is very similar at 4.2% for WOW and 4.3% for COL. We estimate that over the past three years, WOW has gained market share to around 36% while COL has slipped to around 29%. It is clear that independents and convenience stores have gained some share during that time frame.
Online sales in Australian Food declined by 10.8% to $1.2 billion as customers returned to shopping in-store. This emphasises the substitutional nature of online supermarket shopping for many people and supports our thinking that online gains have largely been offset by losses in stores. Online penetration of total sales in 1Q23 slipped to 10.2% just beneath the FY22 level of 10.3%. At this level WOW’s online penetration is much higher than the 7.7% at Coles. Perversely, the higher online growth at WOW has meant a slightly weaker store performance compared to COL over a three year period. In total, the 3-year CAGR total sales growth at WOW of 5.3% was better than COL at 4.7%.
Inflation reached 7.3% at WOW in the quarter. We think inflation will persist at this level for the next two quarters and will contribute to better sales growth. Underlying volume has been quite resilient as might be expected given the staple nature of the supermarket business.
New Zealand Food sales declined by 2.5% in the quarter reflecting the higher sales in the prior year due to COVID lockdowns. Only supermarkets were allowed to open during this period in Auckland. Again, a three year sales comparison is more instructive which showed sales increased 4.7% on a compound annual growth rate basis. EBIT margins in New Zealand are likely to trough at around 3% in 1H23f with wage growth hitting 12%. As price inflation catches up, we think sales and margins will improve in time.
BIG W comparable store sales increased 29.9% in 1Q23. Lockdowns in the prior period flattered the outcome but an underlying shift in consumer spending to value products is also likely to have occurred. We believe BIG W has a good inventory position and should enjoy a strong Christmas period with little promotional activity likely.
Investment View
The low sales growth recorded in 1Q23 marks the passing of lockdown-boosted sales over the past two years through the pandemic. From here, inflation is helping sales growth and consumers continue to head back to shopping in-store. The New Zealand business will follow suit although it is slightly behind in time frame. BIG W is coming into its own through a period of heightened consumer fragility due to higher interest rates and inflation.
Fair value for WOW remains around a PE ratio of 25x, in our view and consensus forecasts are less confident for now. The time is right to re-visit our recommendation on WOW and we upgrade it to a Buy.
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 upgraded our recommendation to Buy.
Figure 1: 1Q23 sales
