Battle of the titans: Coles vs. Woolworths, Pepsi vs. Coke

Competition between Coles — owned by Wesfarmers (ASX: WES) — and Woolworths (ASX: WOW) is at its best when the behemoths focus on bamboozling each other rather than the grocery store on Main Street. One of my favourite stories in the ongoing battle is how Coles managed to buy one of the most profitable Woolies stores. Can you imagine the look on the face of Woolworth’s management when they found out?

Coles bought the building that houses the top-performing Woolworths store for $40 million through a company called Sino Ace Investments, which was controlled by another company that was registered in the British Virgin Islands. Investors should note that in most cases the registration of a company in the British Virgin Islands is a warning sign. Cases of fraud or poor governance are more common when companies are registered in tax havens that protect the identity of the true owners.

In this case, however, the anonymity was required for the sneaky purchase, and the property has now been transferred to Coles for the symbolic price of $1. Woolworths has tried to save face by pointing out that Coles will receive a poor return on the $40 million invested, which was above the prevailing market rates. However, as part of the terms of the lease, Coles gets to inspect Woolworths’ sales and eventually Coles will be able to boot Woolworths out. It’s fair to say that Coles won this round.

Caught in the crossfire are all the smaller stores, which are invariably threatened by the arrival of one of the big players. Distribution company Metcash (ASX: MTS) supplies most independent bottle shops and supermarkets in Australia. Metcash has struggled in recent years, with sales, cash flow and earnings all down on a per share basis in FY 2013.

However, at the current price of $3.35 Metcash yields a hefty dividend of 8.35%, fully franked. The company raised about $375 million in FY 2013, and invested the capital in acquisitions and the automation of its distribution centres. If this spending pays off, Metcash is likely to be able to maintain (or grow) its dividend in the long term. In this scenario, modest capital gains should complement the impressive dividend to result in more than satisfactory returns for investors.

Coles and Woolies aren’t the only duopoly doing battle in Australia. In May this year, the Australian Coca-Cola distributor Coca-Cola Amatil (ASX: CCL) announced that the company had responded to aggressive discounting by competitors with a resulting “impact on short-term price realisation and hence profitability.”

In plain English, this means that despite the oft-touted pricing power of Coca-Cola, the Australian licensee of the Pepsi brand Schweppes Australia, was able to force a reduction of margins upon Coca-Cola Amatil. Schweppes Australia is a subsidiary of the Japanese company Asahi Group Holdings (NASDAQ: ASBRF).

Foolish takeaway

Interestingly, the local licensees of the power brands like Pepsi and Coke are some of the few companies with the might to stand up to the duopoly retailers. It’s conceivable that there would be some backlash against a big supermarket if consumers couldn’t buy either drink there. Furthermore, Coca-Cola Amatil and Asahi Group are big enough to use their political and PR clout against Coles and Woolworths. A big brand is a powerful asset.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article.

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