Prospects for a broader price war in the Australian grocery market look likely following a significant earnings downgrade from Woolworths, Craigs Investment Partners broker Peter McIntyre says.
Woolworths, which operates in New Zealand through Countdown, had less to lose in a price war than its competitors.
At its profit briefing late last week, Woolworths provided first half 2016 reported profit guidance of $A900million ($NZ952million) to $A1billion ($NZ1.06billion), which was not the norm for first quarter sales updates and was contrary to previous comments guidance would no longer be provided, he said.
The new guidance represented a 28% to 35% fall from first half 2015 on a normalised basis.
At an earnings level before interest and tax, the new guidance represented a first half reduction of about $A600million year on year for food & liquor.
The key drivers of the fall were the accelerated price investment, a new loyalty programme, investment in service combined with deleveraging.
Woolworth's first quarter sales were in line with Craigs' expectations. The were slightly lower for food and liquor, in line for general merchandise and slightly ahead for New Zealand, homes and hotels, Mr McIntyre said.
''However, the guidance was far worse than expected which prompted material downgrades to our estimates.''
Craigs' now forecast full year 2016 profit of $A1.77billion, implying a fall of 28%. The earnings revisions were almost entirely driven by Australian food and liquor, with only minor revisions to other divisions, he said.
''In our view, these events are negative for the broader food retail sector. The deep earnings reset raises the prospects of a price war.''
The earnings guidance implied a food and liquor margin of 5.8% for Woolworths, only 0.4% ahead of Craigs' current forecast for Coles.
While Coles was executing well and not suffering the same operating deleverage as Woolworths, its margins could come under pressure.
Coles sales density would likely surpass that of Woolworths but Woolworths was still a significantly larger business which should provide some benefits against the fixed supply chain costs.
Its supply chain was also more sophisticated and efficient, Mr McIntyre said. Woolworths' liquor business was also significantly more profitable than Coles, which was another reason its margin should be higher.
''If an aggressive price war does erupt, we expect independents will be the biggest losers, given the relatively thin margin which is shared between the retailers and Metcash.''
New Zealand supermarkets reported sales growth of 2.5% in the first quarter, well above expectations of 1.2%, he said.
Management highlighted it intended to continue to lower the everyday price of groceries through its ''price lockdown'' programme. As a result, 595 additional products were added during the quarter. Management also highlighted it saw growth in customer numbers as well as market share.
Craigs maintained a hold recommendation on Woolworths shares, a core holding for long term investors, but reduced its target share price to $A23 from $A27, Mr McIntyre said.
