Is Aldi a threat to Woolworths?

With almost 950 supermarkets, 900 liquor stores and control of 39% of the grocery market in Australia, Woolworths is a giant of domestic retail.

The size, dominance and profitability of the business has made it a fine investment for decades but, more recently, there has been concern that the era of domination might be over. Sales growth has slowed; Coles has been reborn as an effective competitor while Aldi and Costco are growing market share.

Aldi, in particular, generates fear bordering on hysteria among investors. The German upstart has come from nowhere to earn 10% of the local grocery market and already operates 350 stores earning revenues of $4bn.

Some claim that a model of lower prices, less inventory and simple logistics have upended the traditional grocery model and now threatens the incumbents, Woolies and Coles.

Aldi doesn't have a hope of replicating the store network or revenue base of Woolies. But that doesn't mean it's a benign force. In suburbs where an Aldi store exists, prices – and profits – at Woolies are lower. The threat from Aldi is not that it challenges the dominance of the leader but that it forces margins lower.

Woolies boasts operating margins that are more than twice the international average; they are five times larger than French giant Carrefour.

If Woolworths generated margins in line with Tesco or Costco, EBIT would be $1.8bn rather than the $3.8bn it earned last year. If it earned the same margins as Carrefour, profits would be under $1bn. It's clear that, compared to international peers, Woolies over earns.

The company doesn't have to lose domination in order to suffer; a normalization of margins would hurt profits even as it leaves Woolworths domination untouched.

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