Woolworths' comfortable lead

When Richard Goyder studies Woolworths' first half results he will have mixed feelings. On one hand, it will give him some insight into the potential of Coles' food and liquor businesses if they are managed to their potential. On the other, Woolworths' performance is downright intimidating.

It is the consistency of execution that is Woolworths' strength. Even with the transition from long-serving chief executive Roger Corbett to current CEO Michael Luscombe, Woolworths hasn't faltered. It's still delivering solid high-single-digit sales growth in the key food and liquor businesses (8.1 per cent), earnings before interest and tax growth is tracking in the high teens (19.3 per cent) and the group continues to steadily reduce its cost of doing business (down 14 basis points).

Woolworths is still working Corbett's famous "productivity loop”, with sales up, costs down and the benefits shared with customers in the form of lower prices to drive further sales. The higher volumes generate higher margins, earnings and return on capital.

Luscombe, who said Woolworths had absorbed some of the food inflation during the half, is in a terrific position, given that Wesfarmers is about to start a very serious restructuring of his major competitor. He showed us last year, when the protracted sales process for Coles was distracting and destabilising the group, that he is prepared to use price to pressure his competitor. He has the financial flexibility to do it again.

The sheer volume of cash pouring through the Woolworths portfolio – cash flow from operations was up 38 per cent in the latest half – allowed Luscombe to invest an additional $550 million in his business without impacting on his free cash flow. With a lower cost base and cash pouring through the group he can undercut and outspend Coles and plans to do so.

There are two reasons for stepping up the attack. One is to keep the pressure on Coles during the most sensitive period of Wesfarmers' ownership in order to extend Woolworths' dominance. The secondary motivation would be the more remote hope that if it can exert enough pressure, Wesfarmers might be prepared to offload one of the Coles' non-food discount businesses to reduce the risk it took on by acquiring the business.

Luscombe would be aware that the Wesfarmers' model – under which Coles will be broken into individual brands run independently of each other within the framework provided by Westfamers' famed financial discipline – will create far more focus within the Coles supermarket business.

With British retailing guru Archie Norman consulting to Wesfarmers and his protg Ian McLeod having been recruited from the UK to run the food and liquor group, Luscombe isn't about to relax the relentless pressure he and Corbett have applied to the market.

Until Coles successfully completes its own supply chain restructure, narrows Woolworths' structural cost advantage, counters Woolworths ‘fresh' offer with a vastly improved offering of its own and stops the bleeding of market share and volume, Luscombe has a large window of opportunity.

There is nothing in Woolworths' history – or Luscombe's own relatively brief tenure as CEO – to suggest he will do anything other than ruthlessly take advantage of it.