Our updates, free in your inbox:

or click here to talk to us about securing a better financial future

Australia’s duopolies are breaking down.

For many years, almost decades, Australians have endured a business environment where two was good company and three was a crowd. That was very good for profits but not for consumers.

 

As Woolworths CEO Grant O’Brien starts to pack his apron away, he will leave a company that has enjoyed a decades-long dominance of Australia’s supermarket industry alongside Coles. That dominance has reaped tremendous profits and dividends for the company’s shareholders.

 

Dividends at WOW have averaged a gross yield of 5.3% every year for the last twenty years while the share price has added 13.2% per annum over that period, at least until the end of FY14. Shareholders have had little to grumble about thanks to the very astute management and growth plans centred on the food and liquor retailing businesses at the heart of the company.

 

Despite periodic inspections, the ACCC has not found that Australia’s supermarkets were operating outside the competition laws and that helped WOW to generate world-leading operating earnings margins of almost 8% in recent years.

 

Both supermarket chains’ food and liquor businesses have been so powerful that suppliers have almost always been on the weak end the deal, and even the multinational food manufacturers would probably not deny this.

 

But when duopolies get to the point where margins are plump and growth in the core business begins to mature, the opportunity for new market entrants opens up.

 

Aldi’s entry into the supermarket industry has been welcomed by consumers who have helped propel the chain towards its target of 300-400 stores. If the momentum is maintained, landlords like Stockland Group suggest Aldi could realistically push towards 600-700 stores.

 

While Costco seems happy plodding along with its slow and steady strategy, German retailer Lidl is now eyeing up a potential push as well.

 

Despite the fierce and sometimes sneaky battle for land grabs of potential store sites by the incumbents, Aldi has shown that it can be done and Lidl will no doubt have a jolly good crack as well.

 

It’s almost impossible to know what Aldi’s sales figures are, and therefore what market share it has attained as it doesn’t even report these numbers to its landlords. Aldi’s rental payments aren’t based on turnover.

 

Both Woolies and Coles have regularly reported large amounts of ‘reinvestment’ into food prices, especially the ultra-competitive fresh food categories, in order to maintain foot traffic and market share of supermarket sales. The price reduction strategy is also about gaining greater scale to make the distribution chains ever more efficient.

 

It is certainly not the end of the profit trail for either Woolies or Coles in the supermarket business, but the margins are about to undergo a long term diet.

 

Woolworth’s more immediate problem is how to extricate itself from the Master disaster. The plan to build a ‘home improvement’ business almost from scratch was ambitious and although WOW appeared to have deep pockets and a bucket of patience, it does look like the board must now take a hard decision to admit the plan has failed. The cost to exit will be enormous, perhaps north of $500 million, and it has clearly contributed to the demise of Mr O’Brien and several of his executive team.

 

Whoever takes the apron from Mr O’Brien will probably cut even deeper into the assets and operations of the group to clean up what has already been started. Investors should wait to see how that plays out before thinking about a contrary move back into WOW shares.

 

Owning Wesfarmers remains preferable but this is based on the incredible profits being driven from Bunnings. WES itself is not particularly cheap.

 

Airlines

 

Qantas has seen domestic competitors come and go for many years but it has always had plenty of regulatory help fending off the international competition.

 

The rise and rise of the ME3 carriers (Middle East – Etihad, Emirates and Qatar Airways) along with the potential deluge of big Chinese carriers is changing the international game for QAN.

 

The joint ventures agreed with Emirates and now American Airlines will both provide some shelter from the direct heat of new international capacity, but it also means giving up a little of the dominance that QAN always enjoyed.

 

The fortuitous dip in the oil price that began mid-2014 will provide a windfall benefit to QAN’s near term earnings. In combination with a huge cost-out and rationalisation program, QAN will appear to have turned a corner.

 

But the likelihood is high that international capacity into Australia will eventually exceed demand. For long term investors, owning Sydney Airport (SYD) would be a better alternative than QAN, despite the very high valuation metrics on SYD.

 

As an aside, Qantas was named the 10th best airline at the Skytrax World Airline awards this week, ahead of Air New Zealand at 17th and Malaysian Airlines at 24th (down from 18th). Qatar Airways grabbed the top gong ahead of Singapore Airlines. Delta Airlines at 45th was the best of the Americans and it just edged out Aeroflot at 47th, American Airlines at 79th while United Airlines did not appear on the list of the top 100.

 

Air New Zealand snaffled the best Premium Economy award. Singapore Airlines was rated the best Business Class service with Qantas placing 7th in the category.

 

Telecommunications

 

This sector has seen some considerable activity in the last year and while Telstra remains the dominant player, the batting order below has changed a bit.

 

Amcom and Vocus have now tied the merger knot, despite TPG Telecom (TPM) acting like a third wheel with its 19.99% stake.

 

TPM hasn’t quite tied up the loose ends of its IIN takeover but subject to a little more ACCC review time and the IIN shareholder vote, it will probably succeed. That changes the order of the Australian broadband market as Optus slips back to number three.

 

CEO Allan Lew has given Optus a big upper cut and finally got its mobile business back into gear. It will be interesting to watch how he can re-position the fixed line business.

M2 Group may have missed out on the IIN prize, but it has proven to be a good operator in the mid-Australia market.

 

My preference remains TLS and TPM as the former has a very strong position across the industry while TPM has proved adept at building its own capacity and backfilling it with plenty of customers.

 

That’s a very simplified version of the sector but it will pay to keep a close eye on how the NBN begins to affect the dynamics of the industry as it gains more scale and penetration.

Leave a Reply

Your email address will not be published. Required fields are marked *