Risk Off Puts Supermarkets In Focus

This story features WOOLWORTHS GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: WOW

The Risk Off environment has once again shifted the limelight onto the two major supermarket operators on the ASX.

-Investor focus is shifting towards defensives such as Coles and Woolworths
-Could the ACCC report provide an opportunity?
-Coles has the upper hand over Woolworths for the time being

By Mark Woodruff

A persistent Risk Off environment for US and Australian equities amidst ongoing uncertainty about US policy decisions and their economic impacts is forcing investment portfolios to once again focus on defensives and safe havens.

In Australia, the focus has sharpened towards supermarket operators Woolworths Group ((WOW)) and Coles Group ((COL)).

In a recent sector update, Morgan Stanley reiterated its preference for supermarkets over discretionary retailers, citing relative valuation appeal, defensive positioning, and FY26 earnings growth profile.

Macquarie also has greater conviction in defensive exposures (particularly supermarkets given low valuations), pointing to concerns over slowing global growth due to tariffs and a potential buying opportunity ahead of the ACCC’s final report on supermarkets.

Staples are trading at a -20% relative P/E multiple discount to discretionary retailers, highlights Morgan Stanley, marking a ten-year low between the two categories.

Benign inflation and moderately positive volume growth have kept sales growth solid for supermarkets, but deeper analysis shows per-capita volumes remain in decline, partially driven by leakage to non-grocery players.

Management teams at Coles and Woolworths have pointed to weak sales in non-food categories and loss of share to non-supermarket players.

Non-food comprises around 20% of supermarket sales and generally offers higher gross margins than packaged foods and fresh, highlights Citi.

This broker also points to material price differences between major supermarkets and Chemist Warehouse ((SIG)), Amazon and Bunnings ((WES)) in the household cleaning, pets, and personal care categories.

Coles recently announced it has lost -$100m in sales to non-supermarket players every year for the past four years, equivalent to circa -0.25% of total annual sales.

Citi suggests several strategies, including a shift towards an everyday low price (EDLP) model to drive customer loyalty and enhance price perception. The broker also advocates for price reinvestment, funded by cost savings and supplier contributions, to narrow the pricing gap with non-supermarket competitors.

To better compete with Bunnings, Citi sees an opportunity to improve unit pricing by offering larger pack sizes, while expanding private label offerings could provide customers with lower-priced alternatives to branded products sold by Amazon.

The analysts also note the pending ACCC grocery pricing report could help mitigate market share losses if it establishes clearer guidelines on recommended retail price (RRP) communication.

Citi also highlights Click & Collect (C&C) is a key differentiator for the major supermarkets, helping to minimise share losses to Aldi and others.

Supermarket customers are increasingly switching to C&C from in-store purchases, with this channel now accounting for around 40% of online supermarket sales.

While cost may blow out to circa -$1.5bn by FY30 in the absence of new measures, Citi points out putting a price signal in place (i.e. a charge) has the potential to lift in-store sales, provide room to reinvest into pricing (particularly in non-food), and grow earnings.

C&C is a more profitable channel than delivery since it avoids delivery costs and generates a much larger average basket of circa $150 than the overall average basket of around $50.

For Woolworths, Macquarie believes improved operating performance could stem from a strategic reset across its business units (e.g. New Zealand or Big W) and a broader optimisation of assets and scale within its core Australian Food segment.

Higher shelf prices (despite occasional deep discounts) have in Morgan Stanley’s view contributed to share loss over time, which suggests Woolworths may follow Coles by simplifying its discount program while also initiating more everyday low-price products.

In the first half to December, Coles experienced double-digit ecommerce growth across all propositions, same day delivery, next day delivery, rapid, and C&C.

Ecommerce remains a strong performer for both Woolworths and Coles with first-half growth of 21.7% and 22.2%, respectively.

Woolworths’ ecommerce grew more in dollar terms, though Coles grew more quickly in percentage terms off a lower base, explains Morgan Stanley.

Macquarie contemplates potential upside from the ACCC report on supermarkets.

As per previous enquiries into the banks, Qantas Airways ((QAN)) and childcare, the broker observes the market tends to “sell the rumour” and “buy the fact”, with share prices materially improving after the release of the regulator’s conclusions.

In this instance, Macquarie believes the re-rating opportunity is greatest for Woolworths given its five-year low relative valuation compared to Coles Group.

Cost management

Significant increases in depreciation and amortisation (D&A), interest costs, and one-off supply chain expenses, along with ongoing cost inflation, are driving a continued focus on cost reduction for both Woolworths and Coles.

Morgan Stanley observes the February reporting season underscored this emphasis, with Woolworths announcing a -$400m above-store cost reduction initiative, though the extent of reinvestment remains undecided.

Meanwhile, Coles’ cost-saving measures fully offset wage and other cost inflation in the half.

Recent sector views 

Macquarie maintains its preference for Outperform-rated Coles, with margins continuing to benefit from supply-chain investments.

As a result of Coles’ Simplify & Smarter Initiatives (SSI) program and a wind-down of dual running costs, the analyst anticipates FY26 will be a particularly strong year for the group, with earnings having been the key driver of recent share price performance.

Macquarie has also upgraded its rating for Woolworths to Outperform from Neutral. While it may take some time, the broker sees upside potential via both a re-rate as the market becomes comfortable with risks around the ACCC report and following the Federal Election which must be held by May.

Despite having the largest Australian supermarket network (around 1,100 locations), Woolworths has been more exposed to de-leverage impacts across the sector, explains Macquarie, with earnings (EBIT) margins declining by around -90bps in the first half of FY25 compared to a year earlier.

The suggest\ion made is management’s ability to manage costs and leverage broader scale may create an opportunity for margin improvement from a lower base.

Morgan Stanley has upgraded Coles to Overweight after removing the previous discount applied to its valuation due to improved performance across a more streamlined portfolio.

This broker cites a favourable margin trajectory driven by the removal of transitional supply chain costs, improved execution, and top-line momentum from ecommerce share gains.

While Woolworths (Overweight) is generating higher ecommerce revenue, Coles is expected to continue gaining market share as its customer fulfilment centre (CFC) investments scale-up.

Citi agrees with Macquarie in favouring Coles, rating it Buy compared to a Neutral stance on Woolworths.

Average targets and ratings

All up, there are seven brokers covered daily by FNArena researching Woolworths Group, comprising three Buys (or equivalent) and four Holds.

The average target is $32.15, suggesting more than 14% upside (excluding the dividend) to the latest share price.

For Coles Group, seven covering brokers are divided over five Buy ratings and two Holds, with an average target of $21.44, more than 15.50% above the share price around $18.65.

Outside of daily coverage, Goldman Sachs and Jarden both have Buy ratings for Woolworths with an average target of $36.55, while each broker has a Neutral rating for Coles (average target $19.25).

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