Woolworths Puts Customers Ahead Of Profit

Australia | 2:15 PM

In the wake of the war in Iran, Woolworths has elected to take a hit on margins rather than push up prices for struggling consumers.

• Woolworths beats on sales in the March quarter
• Woolworths will absorb fuel costs and freeze some prices
• Management believes customer faith needs to be restored
• Analysts feel this is the right approach

By Greg Peel

The war in Iran has caught supermarkets between a rock and a hard place.

The spike in fuel prices has pushed up the cost of production for suppliers of food and household items, and the cost of transporting goods to stores, suggesting retail prices need to rise in order for margins to be maintained.

But so too have costs risen for consumers, suggesting value is now all-important and higher prices are likely to lead to lower demand for higher-end groceries.

It does not help that Woolworths Group ((WOW)) has recently been dragged through a long-running and well-publicised “fake discounting” scandal that has eroded customer faith, which needs to be won back. The saving grace is its main rival is suffering the same fate.

What to do?

Appreciating it needs to win back faith and keep customers on side at this difficult time, Woolworths has elected to absorb an extent of the additional cost and “invest in price”, leading to lower margins.

To invest in price, Woolworths will introduce a "Price Freeze" for 12 weeks across 300 own-brand and exclusive label items, including eggs, bread, chicken, sausages, pasta, and nappies, for three months from May 1.

The March Quarter

The war began on February 28, meaning the impact played out only in the last month of the quarter, continuing into April.

Woolworths surprised with March quarter Australian supermarket sales growth of 5.9% year on year, in-line with a trading update provided in pre-war February of 5.8%, and tracking ahead of consensus forecasts for the second half FY26 of 4.6%.

Sales growth of 5.4% achieved in the March-April period suggests underlying trends are solid for the top line. However, sales were cycling disruption from last year’s industrial action, the period included an earlier Easter along with Anzac Day, and there was evidence of war-driven “pantry stacking”.

Toilet paper shelves were not cleared out, but clearly consumers have not forgotten their covid experience.

The benefit of strong sales growth is not passing through to earnings as a result of higher fuel costs and the other initiatives to drive value for customers.

This intent is already evidenced, Macquarie notes, by average price growth ex-tobacco of -1.0%, despite rising inflation, in the March quarter.

These two factors resulted in FY26 Australian Food earnings growth guidance returning to simply “mid-to-high single digits” rather than a previously guided “upper end of the mid-to-high single-digit range”.

Ord Minnett models the downgrade at a relatively modest -$60m, and while other factors –-faster online growth, consumers choosing lower-priced brands, and higher growth in low-margin segments, such as some meat products-– played a part, the direct impact from energy costs was the single largest contributor at around -$15–25m.

Elsewhere, New Zealand Food revenues grew 2.5% year on year in the quarter, while in NZD terms, the business reported growth of 1.4%, broadly consistent with Bell Potter’s expectations of a softening NZ consumer.

NZ Food earnings are guided lower year on year due to a slower transformation progress than expected weighing on sales growth, higher fuel costs and store operating model disruption, UBS notes.

Big W sales were up 3.9% year on year and modestly stronger than the first 8 weeks of trading, while Petstock sales were up 15.9%.

Big W reiterated guidance of positive earnings and cash flow for FY26 as while sales growth remains modest, the quality (ie gross margin) is better.

The Competition

Writing in the wake of Woolworths' March quarter report, Ord Minnett suggested the sales performance is still likely to outpace arch-rival Coles' ((COL)) and confirm Woolworths’ grip on the No.1 spot.

Coles reported supermarket sales growth of 4.0% in the quarter, well below Woolworths’ 5.9%, albeit in line with consensus and ahead of the 3.7% reported in a February trading update.

However, it is not quite an apples-to-apples comparison, as Coles was impacted by a worse than expected decline in liquor sales. Woolworths previously spun off its liquor exposure to Endeavour Group ((EDV)).

Indeed, Citi noted the sales gap to Woolworths Group ((WOW)) appeared to be reducing into April.

Woolworths is now getting back to basics, Jarden suggests, putting the customer first and ultimately this should ensure strong top-line momentum is sustained for longer. The question is; will there be a competitive response?

Unlikely, in Jarden’s view. Woolworths Price Freeze prices are on par with Coles and above Aldi, the market is rational, Aldi is pulling back on its (comparable) branded range, and promotional intensity is similar quarter on quarter.

Jarden suggests Woolworths is playing a long game, focused on building sustainable trust with consumers, growing share of wallet and becoming the “primary shop”. The broker sees evidence of this across the March quarter result and actions taken on the outlook.

Jarden continues to believe Woolworths's scale, supply chain and data capabilities put it best placed, along with Wesfarmers ((WES)), to take the largest share of wallet in Australia.

The key test is its ability to do this sustainably, while growing return on invested capital, and Woolworths’ earnings guidance downgrade raises questions over the latter.

Looking Forward

Things are only going to get worse.

While the price of fuel shot up the day after Trump/Netanyahu bombed Iran, the impact on food prices is yet to be fully felt.

The high cost of fuel and of fertiliser (and its potential lack of availability) is even leading farmers to question whether planting a winter harvest is commercially worth their while.

The same costs flow into feed for livestock, and thus meat prices.

While stock markets are said to “go up via the stairs and down by the elevator”, oil prices are well known to “go up like a rocket and come down like a feather”.

Even if the Strait of Hormuz was opened tomorrow, it would take weeks for the oil stuck in the Gulf to reach refineries, and weeks more for refined product to reach customers. The oil and gas producing capacity of the Gulf states has been damaged and could take years to repair.

The RBA board, in its infinite wisdom, is expected to raise rates at tomorrow's meeting and further thereafter as inflation inevitably rises, increasing the already crippling cost of living, and potentially driving the economy into recession outside of the energy sector.

Despite the recent moderation in fuel prices at the bowser [a result globally of some vague hope of an end to the war and locally thanks to fuel excise and road haulage charge reductions], Citi expects oil prices to remain higher for longer.

Moreover, Citi notes Woolworths will likely continue to be impacted through the year especially given a lag on contractual fuel surcharges (fuel costs in the June quarter will reflect March pricing).

In terms of price reinvestment, it is unclear whether Woolworths will shield customers from price inflation on 300 staple products beyond the initial three-month period beginning in early May.

It is also unclear for how long the government can maintain its fuel cost reductions, although presumably lost revenue will be countered by higher energy sector tax collections.

Morgan Stanley reports at its conference call, Woolworths noted supplier requests for price increases have to date been concentrated in “fresh”, particularly bread and milk, but dry and packaged good requests are now starting to come through.

While Woolworths’ investment in price is expected to step up in the June quarter, reflecting a decision to help offset inflationary impacts, management expects those impacts to increase through 2026.

Supermarkets don’t want to be seen to be profiting from the rising food inflation while their customers are facing renewed cost of living pressures, Citi notes, particularly with each major supermarket facing its own ACCC legal challenges.

Citi is unsure whether this will be a one-off downgrade or the beginning of a downgrade cycle.

While the top line should be resilient, Citi sees the potential for multiple compression as investors re-assess the premium that Woolworths trades at to the market (27% PE premium on forecast 12 months forward) in light of margin pressures.

Note that Woolworths shares fell -8% on the day of the March quarter report – a hefty fall for a consumer staple.

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