Woolworths Limited (ASX: WOW) and CSL Limited (ASX: CSL) are two of the biggest Australian companies by market capitalisation, and they both started very small. Both companies have gradually and consistently grown their sales networks over the very long term and have now reached positions of dominance. The core reason for this is that both giants have excellent, scalable business models. But which is the better business? And which is the better investment at current prices?
First, lets take a look at one of their main similarities: an extensive distribution network. Woolworths is Australia’s largest supermarket chain, with around 900 stores across the country. The company has 110,000 employees working in retail outlets and distribution centres across the country, and this distribution network is the company’s competitive edge. Because Australia is such a (geographically) large country, it is no easy task to replicate this network. Woolworths further leverages this distribution infrastructure to supply the many pubs it owns, and is branching out into hardware sales.
Similarly, CSL has a TGA-approved distribution network across Australia, as well as a medical products network extending around the world. Indeed, the company has manufacturing capabilities in the US, Germany, Switzerland and Australia, and sells its medicines throughout the globe. Unlike Woolworths, CSL doesn’t own the distribution network entirely, and sells products to regional distributors. Like Woolworths, this network is particularly difficult to replicate, not least because the collection of blood (for CSL’s plasma products) is heavily regulated (and rightly so).
Nonetheless, both businesses have one key advantage in their favour: scalability. Because the distribution network already exists, the incremental cost of increasing sales often results in a high return on investment, because it only requires incremental growth of the network.
Furthermore, as volumes increase, scale allows cost savings. In the case of CSL, this means that manufacturing facilities can be fully utilised. In the case of Woolworths, increased buying power allows the company to squeeze primary producers and reduce margins. In a recent presentation, the Managing Director of CSL said: “We’re scaled, we have capacity, and we’ve been growing all along.” As a result, CSL is “able to manage expenses better than [the company’s] competitors.” The same statement is somewhat applicable to Woolworths (although the company does face stiff competition from Coles).
One key difference between the companies is that Woolworths has much lower margins than CSL. However, this is largely offset by the fact that Woolworths has negative working capital, whereas CSL requires significant working capital to ensure supply. Negative working capital arises when a company can buy products on credit (as Woolworths can) and sell them before payment is due. Because Woolworths sells products so quickly, the company has negative working capital.
Overall, I believe CSL is the better business, because it has a global network, rather than simply a national network. Furthermore, Woolworths is facing growing competition from foreign players such as Aldi and Costco. The market certainly recognises the quality of CSL’s business. CSL shares trade on a P/E ratio of 28, and Woolworths on a P/E ratio of 18.5.
It’s a tough call between Woolworths and CSL at current prices, with Woolworths’ recent improvement in sales suggesting momentum is behind the company. I think Woolworths is more reasonably priced than CSL. However, I favour the healthcare industry due to the ageing population. I also prefer CSL, because of its substantial foreign currency revenues. Over the longer term (10 years or more), I definitely prefer CSL. In the shorter term (about five years), I’d probably prefer Woolworths. In any event, smaller healthcare companies are likely to generate more impressive returns for shareholders, albeit with less certainty.