Woolworths Limited (ASX: WOW) is an iconic brand in Australia, with a lion's share of the local market. However there are intangible issues facing the company that could permanently affect profit margins.
What are these issues?
The strategic errors made by Woolworths' leadership have been widely publicised and the announced departure of CEO Grant O'Brien is only the tip of the iceberg. The hardware chain Masters has attracted strong criticism from analysts for a flawed if not yet failed strategy. Some are saying the money-bleeding hardware chain will not survive. That alone is enough to keep investors on the sidelines for now, as no one really knows the true cost of liquidating these assets.
Estimates carry a substantial margin of error as they depend on the company's ability to find a buyer and what if there is none? Further, if assets cannot be liquidated fast enough, focus is taken away from the true task of realigning the core business.
What's more, if the rumours of 'bad' culture throughout the organisation are true, these issues could prove more costly than the failing Masters strategy. Changing company culture is not only hard to do, but also takes considerable time, effort and leadership and there is no guarantee of success. The cost is intangible; no one knows how big the problem is until it is somewhat resolved.
Competitors Coles, owned by Wesfarmers Limited (ASX: WES), Aldi and Metcash Limited (ASX: MTS) won't sit still either. The battling Metcash already announced that the fight is on by slashing prices across the board. Brace yourself for a new low-margin normal.
Lastly, a very real concern for Woolworths, in fact to all market players, is the threat of new entrants to the industry. While this has not happened yet, there are rumours that Lidl, owned by the Schwarz Group, is eyeing Australia. The Lidl group, an old rival of Aldi with a similar discount strategy, trades in 26 countries and has substantial capital, stamina and know-how to enter the Australian market. If it decides to do so, this would represent a seismic shift to the industry as a whole, as Lidl can challenge all market players on price. The least prepared players will suffer the most and Woolworths seems less prepared than expected.
Foolish takeaway
Woolworths has a very deep market penetration in Australia, so no one believes it will fall to its knees. But Woolworths has no clear strategy how to tackle imminent challenges, an outgoing CEO with no known replacement, corporate culture issues, a need to lower margins across the board and a renewed war on price, including potential new market entrants. Investors should embrace a future where things may get worse before they get better. For those reasons, I would recommend you watch Woolworths from the sidelines and wait to buy.
