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Is Woolworths Limited digging itself into an even BIGGER hole?

One of the great things for consumers about a capitalist society is that businesses making big profits find that competitors arrive to vie for a slice of those profits. This capitalist trait is generally a positive for consumers as it leads to more choice and lower prices.

When it comes to large, highly profitable businesses in Australia look no further than hardware chain Bunnings. The retailer has a market-leading position and enjoys very high margins and returns on capital. At first glance it appears hard to believe, but in terms of earnings contribution to its owner Wesfarmers Ltd (ASX: WES), Bunnings provided $948 million in the last half year. In comparison the Coles food and liquor business provided earnings of $1.6 billion – not bad for a hardware store!

Given the high profits flowing to Wesfarmers thanks to Bunnings it is hardly surprising that Woolworths Limited (ASX: WOW) has entered the hardware market with the aim of grabbing itself a slice of the profit pie.

What is perhaps surprising however are the troubles Australia’s leading retailer appears to be having in rolling-out and gaining traction with its Masters format. According to a report in The Australian Financial Review, to counter this problem, analysts from broker Citigroup believe that Woolworths has been raising prices within its supermarket chain to offset mounting losses within the hardware business.

The worry for shareholders is what the long-term effects of current decisions will be. Investors have witnessed the challenges now facing smaller rival Metcash Limited (ASX: MTS) and the importance of a constantly renewed offering and lowest prices. If Woolworths begins jeopardising its supermarket offering to support its fledgling hardware offering then investors will need to tread carefully.

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

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