With 76% of Australia’s food retail market, just two companies, Woolworths and Coles, dominate the region. In a two-part review, David Robertson looks at both supermarket chains. The first article will look at Woolworths, the second at Coles, while each part will also examine the issues affecting both companies.

Although Australia’s food retailing sector is effectively a duopoly, there isn’t an equal division of power as Woolworths has been the leading supermarket chain for some years. Woolies has so eclipsed its rival, Coles, that analysts have dubbed the Sydney-based company a “South Pacific retail powerhouse”.

Since its chief executive, Roger Corbett, took over in 1999, the company’s share price has tripled while Coles Myer, the parent company of Coles Supermarkets, has been largely stagnant.

But it isn’t just on the stockmarket that Woolworths has outperformed its rival. The company, which has about 700 supermarkets plus 180 Dick Smith Electronics stores and 150 Tandy electronics stores, is forecast by investment bank CommSec to produce sales of A$24.7bn this year with an operating profit margin of 4.55% (a useful measure of how well the company is run). Coles, meanwhile, is forecast to achieve sales of A$19.5bn with a profit margin of 3.87%.

Much of Woolworths’ success has been built on Project Refresh, a revamp of back-of-store operations that has, year after year, wowed investors with its returns. Four years ago, when Project Refresh was in its first stage (involving, among other things, supply chain rationalisation and squeezing the remaining suppliers on cost) savings were estimated at A$185m by 2004. In fact, Woolworths reports that savings have now reached A$3.2bn.

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Top secret strategy

Woolworths is looking Project Refresh savings of A$6.9bn by 2008 – and these consistent improvements have helped drive the company’s profitability and popularity with investors. Nearly all analysts agree that Woolworths is a very well run company and few see this changing, although a downturn in the Australian retail sector could take the edge of future growth.

Merrill Lynch analyst David Errington said recently: “The end result [of Project Refresh and other initiatives by 2008] should be a retailer with a dominant position in the South Pacific region. Provided everything goes to plan, we see Woolworths’ earnings growth accelerating very strongly in a couple of years’ time. As we see it, it will be an investment in Australia that is too good to pass.”

Morgan Stanley also expects Woolworths to continue to perform well with earnings per share growth of 10 to 15% for the next three to five years.

Having completed the first stage of Project Refresh, Woolworths is embarking on the top-secret second stage called Project Mercury. The company went to court last year to prevent a former executive using his knowledge of Project Mercury but it is generally accepted that it revolves around automated restocking systems and other projects. As part of this, Woolworths is looking at outsourcing its national distribution centres for about A$1bn.

A suitable successor

But Project Mercury is about more than just offloading distribution centres: some see it as a move to turn Woolworths into an Australasian Wal-Mart. Rather than have stock in warehouses, Woolworths could use its shelf space as the storage space. This will mean more deliveries but by cutting the capital resources needed to store and deliver tens of thousands of products the company could generate big savings.

Given the success of Wal-Mart in operating a similar system, investors are optimistic that Woolworths will achieve good results. However, it is worth bearing in mind that the product mix (food vs. non-food) in Woolworths stores is almost completely the opposite to that in a Wal-Mart and perhaps this will complicate matters for the Australian company.

Completing phase two of Project Refresh isn’t the only thing Woolworths has to worry about. Perhaps the most pressing issue to face the company is finding a replacement for CEO, Roger Corbett, who is due to retire by August 2006. Given what Woolworths has achieved, and the aggressive culture fostered at the company, the biggest danger in appointing a new CEO will be that he or she destroys that drive.

Citigroup Smith Barney recently said it expected the new boss to come from overseas – possibly Tesco retail and logistics director David Potts, Sainsbury’s chief executive Justin King or Wal-Mart executive vice-president John Fleming.

Opportunity or distraction?

Another issue for Woolworths will be the integration of the 150 New Zealand stores it has agreed to buy from the Foodland Group for A$2.2bn. Some analysts believe the NZ deal is a tremendous opportunity as it instantly gives Woolworths a 44% market share in a new country – particularly given the difficulty of finding new store locations in Australia.

But other analysts are worried that the price is too high and they also wonder how Woolworths will manage economies of scale with stores that are so far away. Also, will this and other acquisitions distract management from Project Refresh?

However, Merrill Lynch’s David Errington believes that the NZ deal will shift Woolworths into a different league: “The position that Woolies will be in in three years’ time, where they will be the largest-scale, lowest-cost provider in food and liquor in Australia and New Zealand, is pretty compelling. They will be a mile ahead of Coles.”

Drive and ambition

Other strategies being mooted by Woolworths includes a move into India using its Dick Smith Electronics stores as a beachhead. The company is expected to announce a joint venture with India’s giant Tata Corporation soon.

Also, Woolworths wants to take on Australia’s pharmacies by offering prescription drugs in-store. This idea has already got pharmacists fuming but it is likely to be popular with the Government as such a move should cut the state’s overall drugs bill.
There are a number of other strategies being pursued by Woolworths and many of them mirror what is going on in other competitive food markets – particularly the US and UK. Both Coles and Woolworths are pushing petrol, non-food products, own-brand foods and alcohol – but more on that in Part II.

All these initiatives – from Project Refresh and Project Mercury to the New Zealand acquisition and prescription drugs – show that Woolworths has lost none of its drive and ambition. Despite having trounced its rival, Coles, for years, Woolworths looks as eager to please its investors as a start-up. Shareholders will have to hope that the Board picks a successor to Corbett capable of sustaining and building on these achievements.