Supermarket profits will benefit from soaring food inflation
The price increases do not stop at milk. Morningstar’s “small basket” detected price increases in a range of categories such as fresh meat and vegetables: 6% for Coles and 5% for Woolworths in the three months ending June 30 compared to the period of the previous year. This compares to inflation of 4% in the March quarter.
However, intense competition, notably from Aldi, is limiting prices.
Investors will see the strength in supermarket earnings over the full financial year this month as the ASX reporting season kicks off.
Early reports from the broader consumer sector were positive, with JB Hi-Fi improving earnings and beating consensus expectations by more than 10%.
But, analysts warn that the next half may not be so rosy in a volatile economic environment.
Revenue growth at supermarkets will be “in good shape” this season as inflation fuels higher prices, says Craig Stafford, head of research at Barrenjoey. But, he is monitoring how supermarkets are handling rising labor and pandemic-related costs.
According to Morningstar figures, Woolworths and Coles are trading high against their respective price targets of $25 and $13.60.
Drawing lessons from the US reporting season, Alex Whight, portfolio manager at Milford Asset Management, said big retailers such as Walmart and Albertsons were showing early signs of “shifting” from national brands to their own brands. distributor and to smaller products.
“It’s not a bad thing for them in some ways in that they’re making much better margins on these private label products,” he said.
Morningstar’s Mr Faul said the extent to which local margins could rise if consumers switched to cheaper supermarket-branded products is a “big unknown”.
“Consumers could switch between products, for example Dairy Farmers milk to Coles brand milk, but they could also switch from beef to a cheaper protein like chicken,” he said.
“We just don’t know how the consumer is going to reallocate all of those individual purchases.”
During the Australian recession of the early 1990s, Morningstar research found that Coles and Woolworths EBIT margins were flat. Aldi was not a factor, entering Australia in 2001.
Transient pressures to soften
Food inflation is driven by a range of dynamics including global and domestic supply chain issues and savage weather conditions affecting the yields and quality of Australian fruit and vegetables. Labor shortages have also affected agricultural production, according to Morningstar research.
Faul believes many of these pressures are cyclical or temporary, saying a deflationary environment is “conceivable” next year.
Morningstar’s initial readings for the September 2022 quarter point to escalating inflation, with average price increases in the mid-teens. However, food price inflation is expected to moderate gradually in FY 2023, averaging in the mid-single digits.