Woolworths (WOW) and Coles (COL) – Defensive or Not?
ARE OUR DEFENSIVE GIANTS REALLY A HEDGE AGAINST INFLATION?
Woolworths (WOW) and Coles (COL) have now both reported first-quarter sales, and both have been underwhelming. The numbers from WOW this morning highlighted a 1.8% increase in group sales to $16.363bn, with Big W seeing the largest revenue growth of 30.1%. But also contained a sour note on the outlook, as inflation and higher interest rates are expected to take their toll. The Christmas season should bring a boost to customer spending habits, but WOW CEO stated, “we continue to see early signs of customer purchasing habits changing, but it remains unclear how much of this relates to cost-of-living pressures compared to COVID normalisation”. The tide is beginning to shift, and consumer spending habits are beginning to change.
Over the last two years, we expected to see some strong outperformance from our defensive supermarkets. Over the last two years, WOW is up 2.7%, and COL is down 8.1%. In a period of economic downturn, with interest rates ripping up, we would expect to see consumer staples stocks outperform, but they have been dreadful performers over that time frame.
WOW noted average food prices in the first quarter increased by 7.3%, while fresh food inflation increased by double-digits compared to the previous quarter. This was driven by bad weather and higher commodity prices. Cost pressures are also impacting the two supermarket giants. Energy prices are going up, so running all those massive fridges and freezers, heating and cooling, and even the lighting is costing more, transportation costs are increasing, and staffing costs are on the rise.
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Looking at the numbers, WOW and COL are very similar companies, as we would expect. WOW is treading on a PE of 23.9x with a yield of 3.1%, which grosses up to 4.5%, while COL is on a PE of 20.3x with a yield of 4.0%, which grosses up to 5.7%. Both have ROEs of around 30% and are expecting single-figure revenue growth in each of the next four years. Dividend growth is expected in the years to come, and both have fairly high payout ratios, WOW is around 75%, and COL is over 80%.
Broker recommendations for COL suggest that inflation is expected to moderate in the new year, but consumer spending habits have changed as a result of the increased cost of living. Following the WOW update this morning UBS notes that despite rising inflation, momentum is not picking up for the food business in Australia.
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More about the author – Layton MembreyLayton Membrey has been working with the Marcus Today newsletter since 2021. He is currently undertaking a Master of Commerce specialising in Finance at Deakin University, which he will complete in 2023. Layton has quickly accumulated knowledge from Marcus and Henry, enabling him to develop his own investment style.