Sales figures throw up few surprises but some major alerts, writes Colin Kruger.
The recent quarterly sales reports from supermarket giants, Wesfarmers-owned Coles and rival Woolworths, did not veer far from the expected script.
Sure. Woolworths delivered flat same-store growth - the worst comparable sales figures most analysts could remember - but claimed market share gains have been hidden by the massive price deflation gripping the industry as last year's floods giving way to an over abundance of fresh produce.
Sales revenue momentum also slowed at Coles, but same store growth of 2.7 per cent showed it is continuing to close the significant sales gap with Woolworths, generating the operational leverage that comes with it.
The two results may not have had many surprises, but investors looking for a safe bet on dependable retail stocks should take a closer look at the details, some of which are causing analysts concern.
The recently reported sales figures are for food and liquor, and both companies have a special relationship with booze. Woolies flat sales were propped up by a successful liquor division, with Dan Murphy's large store format sweeping aside all opposition.
It means Woolies grocery revenues went backwards for the March quarter by up to 2 per cent on a comparable basis, according to the Commonwealth Bank's equity team. This isn't a good look, deflation or not.
"The lack of top-line sales growth is expected to continue in the next two quarters as the peak of deflation persists, resulting in a lack of operating leverage," Commonwealth Bank retail analyst Andrew McLennan, says.
Coles's weakness isn't food, it's booze. In a nice counterpoint to Woolies, Coles liquor sales went backwards for the quarter which means the core grocery business delivered even stronger growth than the headline figures suggest.
Coles admits that liquor has been a harder fix than expected. In the words of Wesfarmers' chief executive Richard Goyder, the business it acquired was "not where the market was moving".
Coles claims the liquor business is next on the turnaround list, but five years after Wesfarmers began revamping the tattered Coles empire it merely highlights the massive task the company has in gatecrashing Woolies' booze party.
Coles management is having to concentrate on closing poorly performing stores while trying to find well-placed real estate to build the large format liquor outlets that are driving the market.
It's probably a tougher task than the one Woolies faces in its challenge to Wesfarmers' hardware business, Bunnings, which has not been troubled by its rivals until now.
At least Coles is recording a good performance where it counts.
"The main game is supermarkets and we're very happy with the way supermarkets are going," Goyder told analysts this week. And they agree.
Merrill Lynch's retail team, lead by David Errington, wondered if Woolies poor food performance isn't a signal that it's protecting profit margins at the expense of sales - citing British supermarket Tesco which was recently forced to surrender margins to stimulate sales growth.
The Woolies boss, Grant O'Brien, rejected the comparison and emphasised temporary factors which hit results like deflation and the unseasonably cool summer.
"If you look at some key categories in our business that we rely on at a time like the summer, ice cream was down 9 per cent, insecticides almost 20 per cent, and cordials were down 8 per cent," he said.
"These are big ticket items in the quarter we just finished."
It didn't convince Merrill Lynch which later wrote that, despite a "significantly slowing sales trend" Woolies remained focused on "sustaining its high margins and heavily investing in new stores".
The store growth, and campaign to stage a multibillion-dollar assault on Wesfarmers successful hardware brand Bunnings, also raises another issue close to Errington's heart - the consequences of overinvestment in a mature market, namely price deflation and increased costs.
"While we accept that produce deflation is likely to ease in the next couple of quarters, we believe price deflation is likely to remain due to increased competitiveness within the industry," Errington said.
"Coles appears to be comfortable in its price-led, volume-driven strategy and we see deflation potentially getting worse as all industry participants continue to invest in sales growth initiatives".
Macquarie equities retail team agrees. Bunnings is planning 91 new stores in addition to the 150 that the Woolies' hardware brand, Masters, has earmarked for the sector, making a total big box hardware/home improvement store count of 421.
Macquarie estimates Australia could comfortably support 240.
The difference between the Buy, Hold and Sell recommendations on Woolies depends on whether brokers believe the only clouds on Woolies' horizon are temporary factors like price deflation from fresh produce which means marketshare gains will then translate into strong sales.
Wesfarmers' Coles may be better-placed with its supermarket business but it is one part of a larger conglomerate, which explains why the Wesfarmers share price is down double-digit levels during the last 12 months while Woolworths is down by a fraction of those levels.
The resource boom's easy ride is over and the company is combating falling prices for its coal and the costs of expanding its operations.
But everyone's got to eat, and the two supermarkets account for 70 to 80 per cent of spending in this category, which gives Woolies and Wesfarmers defensive qualities only the big banks can match - although not quite the same dividend yield.