Woolworths Limited (ASX: WOW) was once considered to be amongst Australia's strongest and most reliable stocks, but its share price decline over the last 12 months shows that may no longer be the case.
Woolworths's shares have fallen roughly 29% since early May 2014. Indeed, this can be attributed to a number of reasons, including the enormous amounts of capital pumped into the loss-making Masters Home Improvement chain, as well as the slow rate of growth experienced in its core supermarket division compared to that achieved by Coles, owned by rival Wesfarmers Ltd (ASX: WES).
While these factors had a huge impact on Woolworths' recent earnings; investors are also concerned about the threat posed by international arrivals Aldi and Costco. Indeed, these companies have the capacity to offer products at extremely competitive prices and have already gained a considerable share of the Australian market, taking away some of the sales that could otherwise have been made by Woolworths or Coles.
Here's how Woolworths and Coles can win the supermarket war
Indeed, many analysts and investors have questioned how Woolworths (and Coles) could possibly hold these discount retailers at bay over the long term. In order to become more competitive, both Woolies and Coles would need to accept lower margins on their products, thus impacting their reported profit levels considerably.
Although price reductions are likely a necessary move (as identified in Woolworths' recent strategic review) there are other ways to combat the growing threat of Aldi and Costco.
To begin with, Aldi itself has acknowledged that it is not a perfect competitor to either business. Aldi Australia's CEO, Tom Daunt, was quoted by the Fairfax press as saying:
"Despite our success over 14 years we do remain somewhat of a niche retailer, with a limited range of very high-quality products sold at heavily discounted prices. The niche nature of our business model won't change into the future, even though Aldi has added more national brands to its private label range and is expanding its fresh offer."
While Aldi's private label range arguably offers greater value than does that of Woolworths, it does not have the capacity to offer such a wide array of products that makes both Woolworths and Coles so important to most consumers.
It could also be argued that neither Aldi or Costco offer the same level of convenience as do their two larger rivals. As highlighted above, customers often have to go elsewhere to satisfy all of their grocery needs while the waiting time in lines can often be longer as well.
Meanwhile, neither chain enjoys the same network effect as either Coles or Woolies do — customers often need to travel further distances to get to their stores (of course, this will change over time, so it is imperative that Woolworths and Coles act now).
Is Woolworths a buy?
Indeed, these are areas that Woolworths and Coles could both look to improve their dominance in the market. Rather than focusing solely on cutting prices and sacrificing margins, they can look to offer superior services and greater availability of products.
Having recognised this, Woolworths has flagged a huge reinvestment into its struggling business which will hopefully revamp sales growth. Although this will certainly impact the retailer's earnings potential in the near term, it does make it an attractive bet for long-term investors – especially given its remarkable 5% fully franked dividend yield.
