Supermarkets in Fast-Growing Digital Business and B2B Model

Summary

• Large businesses are repositioning their asset base and implementing new strategies, as they continue to embrace a new business cycle. Shift to digital channels has intensified after the COVID 19 crisis.
• Supermarkets have committed to invest in large automated distribution centres to improve outcomes for the business through efficiency and cost benefits.
• COVID 19 has also increased cost of operations for supermarkets, including additional hiring of team members. Woolworths continues to review its payment shortfalls to team members, while Coles was served with a class notice related its payment shortfalls.

Supermarkets have committed to invest substantial capital in supply chains for an efficient digital business, which has experienced strong tailwinds in the wake of COVID 19. Woolworths Group, in particular, has been repositioning its portfolio.

In recent years, the group has divested some businesses and continues to be in the midst of a proposed demerger of the hotel and leisure businesses. It is not just Woolworths that is divesting businesses, Wesfarmers also demerged Coles Group and acquired e-commerce retailer, Catch Group.

COVID 19 impacted hotels and leisure businesses immensely. Woolworths has also lowered earnings forecast for its hotel and leisure businesses. Last year, Coles Group incorporated a joint venture to manage hotel and retail liquor businesses.

Under the JV agreement, Coles receives economic benefits of the liquor business, while other partner is entitled to the economic benefits of hotel business. Coles recorded a net gain of $ 133 million in this JV transaction.

Woolworths is seeking to demerge Endeavour Group, which combines its hotel and drinks businesses. Collectively, these two segments delivered revenue of over $ 5 billion and EBIT of over $ 500 million in the half year ended 5 January 2020.

In FY20, the company expects to incur cost of around $ 230 million related to the transformation of Endeavour Group. Although the company has deferred the plan of demerging Endeavour Group, majority costs related to combining hotels and drinks businesses are incurred in FY20. Woolworths continues to expect a total cost of $ 275 million associated with the creation of Endeavour Group as a separate business.

Rising revenues and costs

Panic buying has dragged the revenue of supermarkets to higher levels in the second half of the year, but it has resulted in higher costs of operating with safety measures and increased hygiene processes at premises.

Woolworths, Coles, and Metcash have seen their supermarket revenue increase amid COVID 19 lockdowns. Supply chain capacities were probably stretched during this period, and the Australian Competition and Consumer Commission (ACCC) allowed collaboration among supermarkets for groceries, which was recently extended until March 2021.

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Supermarkets hired additional team members to support the increased demand, translating into higher remuneration costs during the period. In addition, the payment shortfall issues in supermarkets have gathered pace over the year, and even class action notices have been served to the companies.

Woolworths expects to incur $ 185 million in FY20 related to salaried store team member remediation. Excluding interest and other costs, the company expects total cost of remediation to be $ 390 million, subject to further review of awards across the group.

Investments in supply chain

Coles is investing in two automated distribution centres over the medium term, one each in New South Wales and Queensland. Woolworths is anticipating to invest $ 700 million - $ 780 million in technology and fitout of the two planned sites at Moorebank Logistics Park in Sydney over the next four years with an initial lease term of 20 years.

Woolworths expects to fund the two distribution centres through the existing capital expenditure framework. The investment would deliver supply chain benefits and better returns over cost of capital. The company anticipates construction of the two facilities to finish by the end of 2023.

Automated supply chain capabilities would deliver benefits to the business with efficient output. New automated distribution centres will improve the delivery time of goods to stores or customers in addition to scale advantages.

Better supply chain capability will enable to deliver quality service to its customers, and productivity gains for business. Online market is a growth segment for supermarkets at this point in time, and an efficient supply chain is perhaps a quality investment.

Related: With numerous people at home amid COVID-19, Wesfarmers gain traction

Emphasising on core business

After the demerger of Endeavour Group, Woolworths will operate in core retailing segment, emphasising on its supermarkets and stores business. Coles is on a similar path after the JV agreement for the hotel and drinks businesses and commission of fuel business.

It is not just supermarkets that are reverting to basics, this has been going for a few years across industries now – as disruptions and changing consumer behaviours over the past decade – have pushed management to revisit strategies.

This also signals an end of the business cycle and incorporation of a new one with renewed avenues to deploy capital, which will shape the business in this cycle.

ACCC to investigate business plans

Media reports suggest that ACCC is probing Woolworths’ plan for its B2B clients after complaints were received to the commission from distributors and suppliers, who believe their business would shrink as a result.

The supermarket giant intends to increase its share of business in the B2B segment, where it serves schools, childcare centres, etc. Distributors and suppliers have triggered an investigation by the commission to see whether Woolworths’ supply chain plans are deteriorating competition in the industry.

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(Note: All currency in AUD unless specified otherwise)