The Focus Portfolio maintains zero exposure to the supermarkets, which reflects three key considerations:
- Near-term headwinds -
including cost of living pressures (weighing on unit volumes), easing food prices (driving softer revenue growth), and the ongoing regulatory overhang (presenting risks to revenues and margins). - Unattractive long-term earnings growth potential -
as mature businesses facing increasing competition, the supermarkets have limited potential to deliver above-market earnings growth over the long-term. - Valuations aren’t compelling -
the sector’s premium valuation multiple is incongruent with the challenged near-term outlook, and our longer-term expectations for below-market earnings growth.
Looking beyond the supermarkets and the broader consumer staples GICS sector, we see better value in other defensive ‘consumer’ exposures, including The Lottery Corporation (TLC), and Amcor (AMC).
The Supermarkets Have Underperformed
The consumer staples sector has underperformed the broader ASX 200 over the last 12 months, driven by the underperformance of major supermarkets, Woolworths (WOW) and Coles (COL), which represent ~70% of the sector’s index weighting, and are the focus of this report.
The Supermarkets Face a Challenging Year Ahead
1. Cost of living pressures
Cost of living pressures are resulting in downtrading to private label brands, smaller basket sizes, and an uptick in theft among the supermarkets as consumers become increasingly cash strapped and value conscious.
WOW has also highlighted strong ‘competition for customer shopping baskets’ and increasing levels of ‘cross-shopping’ between supermarkets. Over the last six months, customer spending surveys have indicated that heavy switching sales have driven share gains for Aldi (at the expense of WOW in particular). Given the heightened consumer focus on value, Aldi appears well placed to gain further share as its discount offering resonates with households.
In combination, these factors will be a headwind to unit volumes for WOW and COL over the next 12 months.
2. Food price disinflation/deflation
In addition to the weak outlook for unit volumes, the easing of supermarket goods prices will also constrain top line growth over the medium-term.
After benefiting from elevated food price inflation in FY22/23 - which was a tailwind to revenues (given higher COGs can be passed onto consumers) - food prices are now easing rapidly.
This dynamic will weigh on revenue/gross profit growth into FY25, which is unlikely to be offset by higher volumes considering the subdued consumer backdrop.
3. Regulatory overhang presents risks to revenues and margins
The supermarket sector currently faces six separate government inquiries.
Following the ACCC’s review of the Food and Grocery Code of Conduct, which was released on 24 June 2024, the Federal Government has confirmed it will legislate new obligations on the major supermarket chains. The existing voluntary code of conduct will now become mandatory with tougher prohibitions (and significant financial penalties) against making unreasonable demands or threats to suppliers.
Separately, the ACCC’s ongoing inquiry into supermarket pricing and competition (due early 2025) continues to place a regulatory cloud over the sector.
The public perception of ‘price gouging’ and ongoing regulatory reviews are likely (in our view) to weigh on pricing as the supermarkets look to placate customers and regulators by offering better value. Meanwhile, recent reforms to the Food and Grocery Code of Conduct could put upward pressure on COGs (costs of goods sold) given regulatory changes will - to some extent - shift market power in favour of suppliers.
Overall, the regulatory environment presents risks to both revenues and gross margins for the supermarket sector over the medium-term.
The Sector’s Long-term Earnings Potential is Uncompelling
While WOW and COL operate in a highly concentrated (i.e. uncompetitive) market, which has historically underpinned an attractive ROE versus global peers, the competitive intensity of the supermarket sector has never been higher, and competition is still rising.
The success of Aldi in particular has driven market share losses for WOW and COL over the last decade, which is likely to continue over time.
Aldi continues to take share in groceries
Aldi now has ~9.5% market share and ~590 stores (compared to WOW/COL at ~65% share and ~1,950 stores in combination). While the cadence of Aldi’s new store openings has slowed in recent years, there is still ample room for the supermarket to gain a greater share of domestic household spending through continued organic growth within its existing network (particularly in the current environment as value is ‘front of mind’ for consumers).
Non-food competition is intensifying
In non-food categories, share losses have been significant for the entire supermarket sector due to intensifying competition from the likes of Amazon, Chemist Warehouse, Bunnings, among others. WOW has pointed to ‘competition across the whole market’ as a range of retailers are expanding their offering of ‘everyday needs’ (e.g. home care, personal care, pet products, baby goods) to drive traffic and increase basket sizes.
Unattractive long-term earnings growth outlook
The long-term earnings growth outlook for the supermarkets is uncompelling.
The sector has delivered weaker earnings growth than the market over the last ten years, and looking ahead the outlook is becoming more challenging given the increasingly competitive industry dynamics.
Ultimately, as mature businesses operating in a (weakening) effective duopoly, there are limited levers available to WOW and COL to deliver earnings growth that is structurally higher than nominal GDP growth (~mid-single digit % p.a.) over the long-term.
Supermarket Valuations Are Still Too High
While supermarket sector valuations have de-rated closer to our ‘fair value range’, they remain unattractive in the context of near-term sector headwinds, and the sector’s benign longer-term earnings growth outlook.
WOW and COL trade at 12-month forward PE multiples of ~23x and ~20x respectively, both of which represent a premium to the ASX 200 Industrials Index multiple of ~19x.
The sector also remains ‘expensive’ relative to history, based on its pre-Covid average, which in our view provides the best assessment of fair value considering the supermarkets were a significant beneficiary of pandemic-era household expenditure patterns.
Therefore, we remain cautious towards the supermarkets on a valuation basis. The sector’s above-market valuation multiple is incongruent with the challenged near-term outlook, and our longer-term expectations for below-market earnings growth.
Regarding the consumer staples sector more broadly, we also don’t see a compelling investment case for any of the major names on the ASX 100 at this point in time. Our company specific views are detailed in figure 9.
| Name | Ticker | 12 month forward PE | EPS growth | PEG ratio* | ISG view - key considerations | ||
| FY25 | FY26 | 2 year CAGR | |||||
| Endeavour Group | EDV | 16.8x | 5.0% | 5.8% | 5.4% | 3.3 | Not held. After de-rating significantly since its spin-off from WOW, EDV offers better value than the supermarkets (on a PEG basis), albeit we remain cautious due to medium-term risks associated with EDV's greater exposure to discretionary spending (particularly within its hotels segment) amidst the softening consumer environment, as well as the risk of stricter regulation of gaming machines (which are a key driver of group earnings). Longer-term, EDV has more levers at its disposal to drive structural growth (i.e. bolt-on acquisitions, hotel redevelopments), however, downside risks to medium-term consensus forecasts keep us cautious at this point in time. |
| Coles | COL | 20.2x | 4.8% | 12.7% | 8.7% | 4.2 | Not held. COL is not held in the Focus Portfolio reflecting our cautious stance towards the sector, however, on a relative basis it offers a more attractive risk/reward trade off than WOW given its lower PE multiple, stronger medium-term earnings growth outlook, and recent share gains from WOW driven by improved in-store execution. After COL’s EBIT margins were heavily impacted in CY23 by theft and one-off costs (namely distribution/ fulfillment centre investments into Witron/Ocado), EBIT margins are poised to expand in FY25 and over the medium-term as automated distribution centres provide cost savings and theft issues subside following the installation of theft prevention technologies. Overall, COL is expected to deliver stronger comparable sales growth than WOW, while it should also see a better improvement in margins (from a low base) over the medium-term which together underpins a superior earnings growth outlook for COL (relative to WOW). |
| Metcash | MTS | 13.0x | 5.9% | 7.7% | 6.8% | 2.2 | Not held. MTS trades on a lower PE multiple than WOW/COL reflecting differences in its business model (as a wholesale food/liquor distributor and hardware retailer). Over the medium-term we are cautious towards MTS due to downtrading trends (which could drive IGA share losses given its higher average prices). Meanwhile, the hardware segment faces a challenging medium-term outlook due to macro pressures (declining builder confidence, soft consumer backdrop) and increased competitive pressure (with Bunnings being the clear market leader). |
| Woolworths | WOW | 23.0x | 3.1% | 8.2% | 5.6% | 4.1 | Not held. WOW is our least preferred supermarket. The company trades on an excessive premium to the ASX 300 despite consensus expectations for below-market EPS growth over the medium-term, recent market share losses to both COL and Aldi, and our expectations for below market EPS growth over the long-term (as discussed throughout this note). The looming departure of Brad Banducci (in September 2024) after eight years as CEO adds another layer of uncertainty near-term, noting he has been well regarded as an effective leader of the business. |
| ASX 300 | 16.7x | 6.3% | 6.3% | 6.3% | 2.6 | ||
Our Preferred Defensive Consumer Exposures
The Focus Portfolio retains zero exposure to the consumer staples sector; however, the portfolio is exposed to other low beta consumer exposures that have similar defensive attributes to the supermarkets – albeit with more attractive valuations and/or stronger long-term earnings growth potential.
Amcor (AMC) (Focus Portfolio 3%)
As a consumer/healthcare packaging provider, AMC provides exposure to defensive underlying end-markets that have historically demonstrated resilient end-user demand through the cycle. From a valuation perspective, AMC trades on a forward PE multiple of ~13x, which is a significant discount to the supermarkets, and is attractive relative to expectations for mid to high single digit EPS growth over the medium/long-term.
The Lottery Corporation (TLC) (Focus Portfolio 3%)
As Australia’s preeminent lotteries provider, TLC benefits from a relatively predictable earnings profile, which is underpinned by its long-dated monopoly licences and resilient consumer demand for lotteries through the cycle. While TLC trades on a premium valuation multiple, at a forward PE of ~28x, this is justified by its ‘infrastructure-like’ attributes and its attractive long-term earnings growth outlook. Over time, structural growth will be driven by growing digital penetration (given digital sales are ~3x higher margin than retail sales) and ongoing game innovation.
Written by
Greg Burke, Equity Strategist
Greg is an Equity Strategist in the Investment Strategy team at Wilsons Advisory. He is the lead portfolio manager of the Wilsons Advisory Australian Equity Focus Portfolio and is responsible for the ongoing management of the Global Equity Opportunities List.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
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