Australia’s big two supermarkets, Woolworths and Coles Myer, which between them control three quarters of the market, are facing an uncertain future but for sharply contrasting reasons. correspondent David Robertson reports from Down Under.

Woolworths has been a runaway success over the past couple of years and has produced a string of outstanding results. A cynic might point out what a shocking state the company must have been in before this revolution but the problem for Woolworths going forward is that many shareholders just don’t think the company can keep up the good work and are selling out.

Coles Myer has continued to plug away with its supermarkets but the relatively strong performance of the food division has been utterly undermined by a lack of confidence in the rest of the company – which includes department stores Kmart and Target.

But first the good news: Woolworths’ share price has nearly doubled to A$12 (US$6.2) in the last two years and its performance in the 2001 financial year has been impressive with sales up 10%, net profit up by 17.7% and earnings per share up 24%. No wonder chief executive Roger Corbett is a darling of the stockmarket at the moment.

But analysts are sharply divided on where the company goes next. Nobody doubts that it will continue to be a well-run company but that doesn’t matter to investors; they would put money in a basket case if it produced good returns. Morgan Stanley, for example, believes the forecasts for the coming year are too high and claims the stock is now over-valued at a 30% premium to the market.

Other doubters point out that Woolworths’ performance in 2001 has been exaggerated thanks to external factors including a big hike in food prices that hasn’t been matched by inflation. Woolworths has also been sitting pretty while competitors have struggled – not only Coles but also mid-sized Franklins, which disintegrated after a string of poor results.

But there is still room for optimism, claim other analysts. JP Morgan sees Woolworths maintaining this level of earnings per share growth; Credit Suisse First Boston agrees adding that there are few constraints to share price performance. Deutsche Bank sees 15% earnings per share growth as reasonable and has a target share price of A$12.80.

The reality for Woolworths is that maintaining these levels of growth will be very difficult when you control so much of the market – there is little way it can get growth out of building market share so any improved performance will have to be wrung out of what it already does.

But there are a number of factors that suggest it could succeed. Firstly Project Refresh, which has so far delivered A$75m in cost savings and has exceeded management’s wildest expectations. Woolworths revised its Refresh estimates two weeks ago and is now aiming for A$185m in savings over three to four years – that would be equivalent to stripping costs of 1% out of total turnover.

Analysts are impressed and believe that for every A$50m in savings Woolworths will add A$25m to its bottom line – not bad for doing nothing. Another surprisingly positive trend is in the 67 Franklins stores Woolworths bought for A$229m from Dairy Farm International when it pulled out of Australia. These stores are expected to add A$1bn to sales this year and A$1.5bn in 2002. This is 20% more than Woolworths expected and the stores are already trading at 8% above forecasts – no wonder Franklins was losing money.

Woolworths is also expected to expand its alcohol retailing division and the number of petrol outlets, both of which will add significantly to its revenue raising capability.

The doubters may have a point when they say Corbett will struggle to maintain the momentum but it may not be time to sell out now; there are just too many potentially lucrative things happening. Sadly the same cannot be said for Coles Myer, which has had a shocking year – largely due to its own mismanagement.

Change of personnel to revive Coles’ fortunes?

Chief executive Dennis Eck, a supermarket man by training, has continued to successfully run the food operations (sales up 8.5% in the year to 29 July 2001) but the non-food divisions have really struggled. So much so that Eck has been given the elbow and, after a four-month search by Egon Zehnder International, Coles Myer has appointed John Fletcher as CEO. Fletcher had only just retired as CEO of the industrial giant Brambles and his appointment is seen as a strategic move to have a steady hand on the tiller while leaving day to day running of the retail arm to American Warren Flick.

But Coles has some serious image problems to get over. This is how the respected Australian Financial Review described the company: ”

“Coles Myer has become an object of grim fascination, a slow train wreck years in the making that is now acquiring an air of inexorability.”

Coles Myer has become an object of grim fascination, a slow train wreck years in the making that is now acquiring an air of inexorability. It is a company that seems to have become so entangled by failure that it can’t escape, and investors are torn between an attachment to its status as the nation’s greatest retailer and dismay at its inability to turn that status into great profits or to devise a strategy for doing so.”

Ouch. Damning. One proposal is to cut loose the food division so it is no longer burdened by the poor non-food side but there is strong opposition to the idea (which has been rejected by successive managements for the last decade) but the malaise in the retailer is more endemic and some consider it starts at the top with chairman Stan Wallis. The supermarkets missed out on the Franklins’ sell down so won’t get any uplift there but Coles is copying Woolworths by initiating a cost-saving program. But experience suggests that weak management forcing through cost-cutting generally leads to an even poorer product.

Both companies declined to comment on their prospects. Woolworths chose not to comment on differing views on its future performance saying it had complete confidence in the market place, while Coles Myer won’t comment on its performance because it is in the closed period ahead of its annual results.

However, for both Woolworths and Coles the future should be bright but for various reasons success may be derailed by factors they cannot control. Woolworths may fall victim to its own success as investors bail out of a company that has already made them rich and Coles’ supermarkets, with or without cost savings, may remain blighted by the rest of the company even if it continues its sales growth.

By David Robertson, correspondent

To view related research reports, please follow the links below:-

The World’s Top 100 Retailers

The Market for Packaged Food in Australia