Coles, Woolworths: Truce On Fuel Helps Competition

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

-Some discounting to thwart Aldi
-Aldi expansion plans now boosted
-Mixed blessings for Metcash
 

By Eva Brocklehurst

The major Australian supermarkets have been funding fuel discounts at their linked service stations for some time now, a highly publicised route to obtaining customer loyalty and increasing spending at a single shopping trip. Brokers were increasingly questioning the value of these fuel discounts as the offers continued to increase, blowing out recently to as much as 45c a litre on occasion for a $100 spend, in the case of Woolworths ((WOW)).

Wesfarmers ((WES)), the owner of Coles, and Woolworths have now decided to call somewhat of a truce. The pair have provided undertakings to the Australian Competition and Consumer Commission (ACCC) to limit behaviour regarding fuel discounting. They've agreed to limit fuel discounts which are linked to supermarket purchases to 4c per litre. Discounts can be increased through purchases at fuel outlets or through loyalty cards. All fuel discounts must be funded by the fuel retailing businesses, including discounts above 4c per litre where they're not offered to supermarket customers. The undertakings were made as the ACCC concludes an investigation as to whether these discounts were causing a lessening of competition.

Credit Suisse believes the end result of the truce is more beneficial to Woolworths. Wesfarmers started the aggressive fuel discounts as a means to increase the basket size at Coles and Woolworths had to respond and act to protect market share. The reduction in the discounting should favour the independent operators, in Credit Suisse's opinion. JP Morgan thinks expansion into new business, such as insurance, by the pair may be more difficult now without cross subsidy, although the broker concedes that extrapolating the implications of the undertakings is difficult.

JP Morgan also suspects the growth of Aldi has been a reason, in part, for the fuel discounts – in order to encourage larger basket sizes at the main shopping trip and slow the numbers of consumers using Aldi as the prime shopping destination. Aldi's entry into the Australian market spurred a lowering of prices by the major supermarkets, as the ACCC enquiry in 2008 noted prices were lower at Coles and Woolworths stores where an Aldi store was nearby. Aldi intends to expand from its current base in NSW, Victoria and Queensland to a network of 800 stores which includes South Australia and Western Australia. This will amplify the competitive impact but JP Morgan thinks Metcash ((MTS)) will be most affected by the expansion, because of the company's relatively higher market share in SA and WA.

Coles and Woolworths were using the discounts as a promotional lever, suggesting to JP Morgan the spending was a reallocation of funds rather than incremental promotional spending. Hence, the broker does not expect any significant change in the rate of earnings margin expansion for either supermarket. From the second half of FY14 the broker expects petrol in the case of Woolworths, and convenience stores in the case of Coles, to show reduced earnings margin, as the all the fuel discounting is borne by those divisions.

For some time Woolworths has offered fuel discounts at its petrol stations and, when Coles paired with Shell to offer petrol discounts, Woolworths added Caltex ((CTX)) as a partner. The rate of discounting was generally 4c per litre of the price of fuel with a $30 or more docket from the supermarket. Over the last year the competition surged, with Coles offering 8c per litre for most of FY13 and Woolworths stepping up its discounting to meet this. In recent months the two were offering promotions of much higher discounts, coupled with larger spending of over $100 at a time.

Coles disclosed the spending on fuel discounting added up to $180m in FY13. Considering Woolworths has a bigger food and liquor business it's possible, JP Morgan contends, that the two spent a combined $300m on fuel discounts during the year. The broker notes this figure exceeds Metcash earnings, although acknowledges that comparing an expense with earnings is simplistic. While JP Morgan thinks Metcash should benefit from the undertakings, pressure from continued aggressive promotions by Coles and Woolworths is still likely to undermine earnings.

Citi thinks the news is good for Metcash as it may lead to a slowdown in sales at Coles and Woolworths. Petrol discounts were highly visible and provided an edge for Coles and Woolworths over Metcash, Aldi and Costco. This may be reduced and, assuming Coles and Woolworths sales trends slow by 0.5%, Metcash's sales could accelerate by 2%, in the broker's opinion. Citi maintains a Sell rating for Wesfarmers and Woolworths because these stocks are expensive relative to their growth prospects. The broker has a Buy rating on Metcash, which is trading at 10 times price/earnings on FY14 earnings estimates, a discount to its history.

Comparing the listed stocks on the FNArena database Woolworths has three Buy ratings, three Hold and two Sell. Wesfarmers has two Buy, one Hold and five Sell. Metcash has two Buy, three Hold and three Sell.
 

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