Are Woolworths Limited and Wesfarmers Ltd facing a grim future for their petrol retailing business?

Will continued investment in the petrol business prove to be a diminishing returns sinkhole for Woolworths Limited (ASX:WOW) and Wesfarmers Ltd (ASX:WES) shareholders?

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In a series of articles last year when the ACCC was cracking down on supermarket petrol vouchers, I questioned whether our two domestic giants have much of a future in the petrol retailing business.

Since that time, both Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) have experienced total fuel sale volume declines despite opening numerous new petrol stations.

Wesfarmers has delivered 3.5%, 2.3% and -3.9% comparable fuel volume sales over the 2012, 2013 and 2014 financial years, opening 27 new Coles Express stores (total of 642) in this time.

Woolworths recorded comparable fuel volume changes of 0.7%, -1.4%, and -3.1% over the same three years, whilst opening many more stores, with 101 new 'canopies' for a total of 682.

While both grocers continue to record increased earnings growth in their fuel businesses this is largely due to increased sales of non-petrol items, and the decline in volume is commonly attributed to a decrease in fuel docket discounts and more fuel-efficient cars.

However while the fuel businesses continue to look all good at the moment, I have to strongly question whether our grocers – Woolies in particular – have got it wrong.

Are they pouring huge amounts of money into a business line that will deliver diminishing returns?

I think so.

Here's why:

According to the Australian Bureau of Statistics, Australia consumed 31.186 million litres of fuel (diesel and petrol) in 2010, and 31.839 million litres in 2012.

While I couldn't find statistics for 2014, this indicates a 2.1% increase in petrol consumption over those two years.

Hardly a stellar growth opportunity.

I think it is further likely that as more old cars 'retire', Australia will soon hit its peak petrol consumption and volumes will begin to plateau or slowly decline, barring any dramatic demographic or car-use changes.

More fuel-efficient cars means less frequent stops for petrol, which means fewer potential occasions to sell ancillary items at service stations.

Logically I believe this must lead to a decline in petrol station revenue growth, despite the strong performance in this area over the past two years.

Even more critically, it means that more stations are essentially competing for a stagnant or dwindling pool of fuel sales, increasing costs and shrinking returns to shareholders.

Which then begs the question – are Woolworths and Wesfarmers pouring their money into a black hole by continuing to invest in this sector?

Although Woolworths is clearly motivated by its competition with Wesfarmers, it appears to have been the less shrewd of the two by opening such a substantial number of stations in the past three years when demand growth is slowing.

This doesn't necessarily mean that the petrol retailing arms will turn into a write-off overnight, but shareholders should be very cautious about any major increases in investment in this sector.

Woolworths' shareholders in particular should pay close attention to future annual reports since the company is combining petrol with food and liquor sales reporting from this year onwards.

In the interests of shareholder transparency I hope they continue to report their total fuel volumes and number of canopies opened or closed.

Time to sell your Woolworths and Wesfarmers shares?

Maybe not, but there's no need to keep throwing money at them, either.

The Motley Fool's latest top stock recommendation boasts significantly more impressive profit and dividend growth than Woolworths and Wesfarmers in past reporting periods, and has even better prospects looking forward.

A company I already own shares in, it's one I think you might like to take a look at as well.

Since the special report is available for free, there's really no reason not to!

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Motley Fool contributor Sean O'Neill doesn't own shares in any company mentioned.

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