Citigroup warns that Coles is posing a new threat to Woolworths Group Ltd (ASX:WOW)

Shareholders in Woolworths Group Ltd (ASX: WOW) could be facing a rude shock as sales in our biggest supermarket chain could be about to slow, according to Citigroup.

The share price of Woolworths has been on a recovery path with the stock jumping close to 20% over the past year compared to the 9% increase in the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.

But a new promotional campaign from Wesfarmers Ltd’s (ASX: WES) Coles is likely to narrow the gap between the two supermarkets at a time when Woolies’ like-for-like (LFL) sales are losing steam.

“Based on supplier feedback, Woolworths is experiencing a slowdown in sales momentum. We forecast a drop from 4.5% in 3Q18 to 3.3% in 4Q18e, as the company laps 6.4% LFL sales growth in 4Q17,” said Citigroup.

“We expect Woolworths to deliver LFL sales ahead of Coles (1.7% LFL sales growth) in 4Q18e; however Coles’ execution has stopped deteriorating. The gap between Woolworths and Coles LFL sales growth is likely to halve, from 320 basis points in 3Q18 to 160bps in 4Q18e.”

Coles is also about to start its Little Shop promotion in the current quarter. Little Shop is a giveaway of well-known miniature branded products for every $30 spent.

Similar campaigns have been run in other countries with good success, according to Citigroup. These countries include The Netherlands in 2012, New Zealand 2013 and 2014, and South Africa in 2016 and 2017.

“Suppliers have funded a large portion of this program, with minimal incremental investment by Coles, as funding is redistributed from other sources,” added Citigroup.

“Little Shop could boost 1Q19e LFL sales by 50–100 basis points, narrowing the gap to Woolworths further.”

While the Little Shop campaign could lift LFL sales in the short-term for Coles, it will need a longer-term strategy to sustain the sale momentum. Citigroup notes that both supermarket giants have not done a good job of removing single-use bags from their stores and that could drag on their performance.

The broker has a “neutral” recommendation on Woolworths with a $32.90 price target but said it was growing more cautious on the stock in light of these factors. Citigroup has a “sell” rating on Wesfarmers with a price target of $41.10 per share.

Grocery distributor Metcash Limited (ASX: MTS) is also struggling to win back investors since its disastrous profit warning in May and it seems like investors should be wary of the supermarket sector following the big re-rating in these stocks over the past year or two.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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