Will Woolworths and Coles shares be hit by new supermarket regulation in 2024?

Nick Sundich Nick Sundich, April 10, 2024

Woolworths and Coles shares are facing regulatory scrutiny like no other companies are right now. After months of allegations that the pair were price gouging, economist and former government minister Craig Emerson ran an independent review into the Food and Grocery Code of Conduct.

While the worst fears of the supermarkets weren’t endorsed, there is more scrutiny on the companies, and there might be some new regulation coming.


What supermarket regulation is coming?

The Coalition and the Greens have endorsed the idea of breaking up the big supermarkets. Opposition Leader Peter Dutton gave a speech to the Council of Small Business Organisations of Australia where he promised actions would be taken to stop market domination. His part is working on a plan to forcibly break up the supermarket giants.

The Emerson review rejected the idea, and so has the Albanese government – the Prime Minister used the words ‘We are not the old Soviet Union’ to rubbish the idea. And so no one should expect it during this current term of government. The review found forced divesture could actually stifle competition or result in more store closures. Specifically, forced sales from one chain could just happen to the next chain that would have an even greater concentration than before. Alternatively, locals could be left without a convenient grocery story for them.


Big fines

Nonetheless, the review recommended supermarkets and suppliers abide by a mandatory code of conduct, breaches of which could lead to penalties of up to $5.2bn. Specifically, it would be up to 10% of annual turnover, 3 times the benefit gained or $10m – whichever was greater. For Woolworths, it would be $5.2bn, given its $50.2bn annual turnover, whilst $3.8bn for Coles, $1.3bn for Aldi and $880m for Metcash. Among other things, the review also provided for supermarkets to be asked to mediation mechanisms with suppliers or blocked from negotiation out-of-code contracts.

It is important to note that the current code is only voluntary and it remains to be seen if any of these proposals would be mandatory – barring penalties of course.


Will Woolworths and Coles shares hit by new supermarket regulations?

To answer the question, it will depend on what is proposed. But they would only substantially be hit in the event they fell afoul of the law, and they would likely beef up their in-house legal teams to avoid it. And it also remains to be seen if these proposals will see the light of day, or are just a way for the government to convince people they are doing something about the supermarkets.

The irony is that price increases in Australia, at 18.8% since 2020, are actually below the 23-31% average increases in comparable jurisdictions. And both big supermarkets have thin margins, at barely over 2.5%. Of course, this is little consolation to shoppers here and made profits over $1bn in FY23.


History repeating itself

But let’s turn our attention back to investors here. Investors may be concerned about the impact of potential penalties from wrongdoing. What about share price damage just from the scrutiny of the inquiry? That’s a good question, although if the past is any guide, the damage may already be priced in.

It is easy to forget that the supermarket industry has had inquiries before. There was an inquiry in 2008 that was run by the ACCC. It ultimately concluded the industry was ‘workably competitive’ and any changes proposed did not impact the company’s earnings. The only substantial change was that there be a mandatory unit pricing regime for grocery items, but the other two weren’t significant for the companies’ business operations. One was a recommendation that governments consider how zoning and planning laws could impact competition, and that there be new civil pecuniary penalties for breaches of the Horticulture Code of Conduct.

Notwithstanding this, as a recent Goldman Sachs note pointed out, the inquiry (run over the first half of 2008, so before any impact from the GFC) saw Woolworths underperform the ASX by 15-20% – Coles was at the time part of Wesfarmers and not separately listed. And today, Woolworths’ has underperformed the ASX 200 by roughly 20% since December 6.


Which of the two supermarket stocks should investors buy?

In our view, Coles. Despite being only 60% of the size of Woolworths by market cap, it is seeing faster sales growth than Coles with 4.9% growth in the first 2 months of CY24, while Woolworths saw just 1.5%. So it is clear that Coles is performing better right now and is likely to into the future.

One thing investors have exposure to with Coles only is alcohol. The latter company divested out of alcohol when it spun out Endeavour Group (ASX:EDV), but Coles still owns Liquorland, First Choice Liquor Market, and Vintage Cellars. Coles also has the Flybuys program that seeks to rewards loyal customers with various points redemption options and also makes more money for the company. Woolworths has its own, but it shares the benefit with Qantas.

Of course, as we’ve seen with the banks (we’re looking at you Westpac during 2020), any major penalty from regulatory against illegal conduct can turn any growth story into an ‘avoid like the plague’ story.


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