Retailers face cut-throat competition

The next few days will reveal just how tough the economic and competitive environment has become for Australia's biggest retailers.

Tomorrow, Wesfarmers reports first-quarter retail sales for Coles supermarkets, Bunnings and its discount department stores, while Woolworths follows up on Monday with supermarkets, Masters and Big W.

Wesfarmers took the decision last quarter to write down the value of discounter Target by $680 million as it struggled with sliding earnings, excess stock levels and tough competition from other discounters, not least of them its Wesfarmers-owned sibling Kmart.

Investors expect it's only a matter of time before Woolworths is also forced to make a writedown on one of its costliest forays: the Masters business.

The magnitude of the challenge facing Masters has been apparent for the past year, and was crystalised in the full-year results when Grant O'Brien revealed losses of $330 million over two years and abandoned a pledge for the business to break even in 2016.

The attempt to take on arch rival Bunnings has proved costly, even though the dominant player holds only about 17 per cent of a highly fragmented $45 billion home improvement market and the case for consolidation appears strong.

Analysts expect the booming housing market helped drive strong sales growth at Bunnings in the September quarter of between 6 per cent and 8 per cent.

The question is why hasn't the buoyant housing market also benefited Masters? Sales per store have declined nearly 10 per cent per annum according to Goldman Sachs analysts and the chain seems not to have dented the hard-core market of tradespeople that still head to Bunnings.

“At the moment it looks like a disaster,” says one fund manager. “How long the board are happy to capitalise those losses before they take a position is an issue.”

Across the broader retail offering, both Woolies and Wesfarmers are feeling the pinch from the influx of cheap international chains such as H&M that have intruded into a discount clothing market that used to be dominated by Target and Big W.

In the core supermarket business too, Aldi has snatched 10 per cent market share from the duopoly and has announced further expansion. Aldi plans to add 130 stores in Western Australia and South Australia in the next few years, with the cost of up to $700 million to be funded from Australian cashflows.

The juicy margins that attracted foreign players are slowly being squeezed, but competition is only going to increase in the years ahead. The golden years when Woolworths could count on double-digit sales growth year in, year out, while it profited from a weak competitor in Coles are a distant memory now.

As Coles continues to improve its offering, quarterly sales growth in core food and liquor has often outpaced that of Woolworths'. In the September quarter, core like-for-like supermarket sales are expected to show around 3.0 per cent growth for each chain, according to Credit Suisse.

With a tough market at home and consumer confidence still depressed, there is talk that the supermarket giants might turn their eyes to Asia for expansion.

The accounting scandal that has engulfed Tesco may create just such an opportunity if the British supermarket decides to spin off or sell its 2,000 grocery stores in Asia to help shore up its balance sheet at home.

Both Wesfarmers and Woolworths have looked at Asia before, most recently at the ParknShop supermarket chain owned by billionaire Li Ka-Shing, which was up for sale last year but attracted insufficient offers. But whether an Australian chain could add value in a market and region it's unfamiliar with is an open question.

As Woolies has found with its struggling Masters business, an apparently golden opportunity can soon lose its lustre in the harsh glare of the marketplace.