Woolworths: The era of growth and fat margins is over

Woolworths is one of the most profitable grocery chains in the world – and that's the problem.

As the classic disclosure says: Past performance may not be indicative of future results.’ But shareholders of Woolworths (ASX:WOW) could be forgiven for thinking ‘doesn’t apply here’ after 15 years of uninterrupted growth in earnings per share.

The good times came to an abrupt end at the last interim result when earnings per share fell 4%. Nonetheless, Woolworths is still one of the most profitable grocery chains in the world – and that’s the problem.

Aggressive in-store price increases expanded its gross margin but the loss of price leadership is also pushing customers towards competitors.

Woolworths lost market share to Coles in the first half, with same-store sales growth of just 1.7% compared to 4.2% for Coles.

Winning customers back won’t be easy now trust on price has been damaged. To compound matters, customers have many more low-price options than five years ago: Aldi now has a 10% market share in eastern states and Costco has signalled its intention to keep rolling out stores.

Woolworths has two options: keep overpricing groceries to support short-term profitability and margins, but make it easier for Coles, Aldi and Costco to take market share; or, lower prices to tempt customers back to stores, but accept thinner margins and lower returns on capital.

Woolworths has some of the country’s best store locations and arguably its most efficient distribution network, so the company is working from a position of strength. But Woolworths is a big ship – hard to slow, and just as hard to get moving again.

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