ASX Consumer Staples: Broker views and Morningstar’s preferred pick

This article was first published for Livewire Markets on Monday 6 February 2023

It was recently revealed that the real inflation rate for working families in Australia currently sits at 9.1% - well above the latest official inflation rate of 7.8%. During such periods of economic uncertainty and recession fears, the non-cyclical characteristics of Consumer Staples can provide a buffer for investor portfolios.

But what we’ve seen in recent years has differed from other downturns. For example, the COVID-linked supply chain challenges and pandemic mitigation measures knocked supermarkets and others in the space. This was followed by rising inflation and cost-of-living pressures that are still flowing through to the prices of food and other staples.

Inflationary pressures on packaged groceries were recently described as the worst in more than 20 years by Paul Harker, chief commercial officer of Woolworths (ASX: WOW), the biggest local player in the space. But he also suggested there was better news ahead for consumers. “In 2023, there are some reasons to be a little optimistic that the very worst of the inflationary cycle is over,” Harker told the Senate select committee hearing on Wednesday 1 February.

But speculation continues to surge about when inflation will fall. In this feature, I look at how several brokers feel about some of the largest names among ASX-listed staples. Morningstar’s Johannes Faul also weighs in with his views and outlook on the space.

Woolworths Group (ASX: WOW)

With a market cap of $44.4 billion, Woolworths currently leads Coles by around $20 billion in terms of scale. The near-century-old supermarket chain, founded in 1924, is led by CEO Brad Banducci.

Credit Suisse upgraded the company to OUTPERFORM from Neutral on 30 January, analyst Grant Saligari increasing his price target to $36.58 from $33.01.

Morgan Stanley initiated coverage of Woolworths on 7 November, with analyst Melinda Baxter kicking off with an UNDERWEIGHT rating and a price target of $28.50.

J.P. Morgan’s Bryan Raymond downgraded Woolies to UNDERWEIGHT from Neutral on 26 August, cutting his price target to $34 from $35.40.

Woolworths stock was trading at $36.51 at the close on Friday, up from $33.09 at the start of January but down more than 7% from its recent peak of $39.39 in August. WOW has delivered a share price return of 4.92% in the last 12 months.

Coles Group (ASX: COL)

The other dominant player in Australia’s supermarket retailing space, Coles has a market cap of $24.3 billion. Currently headed by CEO Steven Cain, Coles was spun out of conglomerate Wesfarmers (ASX: WES) in late 2018.

J.P. Morgan’s Bryan Raymond downgraded Coles to UNDERWEIGHT from Neutral on 1 February – reversing the shift he made in late October. But Raymond left his price target at $16, in line with the increase from $15.80 he made in the four-quarter of last year.

Morgan Stanley picked up coverage of supermarket chain Coles Group on 7 November, with an UNDERWEIGHT rating and a price target of $13.70 from analyst Melinda Baxter.

Goldman Sachs downgraded Coles to SELL from Neutral on 17 September. Analyst Lisa Deng cut her price target to $15.60 from $17.90.

The Coles share price closed at $17.98 on Thursday, up 10.4% in calendar 2023 so far but down more than 6% since August. It has delivered a 12-month share price return of 9.48%.

Endeavour Group (ASX: EDV)

With a market cap of $12.18 billion, the drinks and hospitality business formerly sat within the Woolworths Group. Demerged and re-listed on the ASX as Endeavour Group in June 2021, Steve Donohue is the CEO and managing director.

Morgan Stanley added the bottle shop chain to its coverage list on 7 November, with an UNDERWEIGHT rating and a price target of $13.70.

Jefferies upgraded its rating for Endeavour Group to BUY from Hold on 1 September, analyst Michael Simotas also lifting his price target to $8.20 from $7.70.

UBS downgraded the stock to SELL from Neutral on 4 August, but analyst Shaun Cousins left his price target unchanged at $7.20.

Endeavour stock closed at $6.81 on Friday, up almost 8% in 2023 so far but down more than 18% from its all-time high of $8.32 last August.

Treasury Wine Estates (ASX: TWE)

A global wine company that in recent years has increasingly targeted higher-end market segments, Treasury Wine has a market cap of $10.6 billion. It’s headed up by managing director and CEO Tim Ford.

Jefferies downgraded the winemaker to HOLD from Buy on 21 December, but analyst Michael Simotas left his target price unchanged at $15.

Goldman Sachs upgraded Treasury Wine to BUY from Neutral on 25 October, analyst Lisa Deng lifting her price target to $14.70 from $12.

Closing at $14.79 on Friday, Treasury shares have gained 12% since the start of January. The company has delivered a 12-month share price return of 36.5%.

The a2 Milk Company (ASX: A2M)

The New Zealand-based milk and infant formula company has long been linked with Chinese consumers, especially in connection with professional “daigou” shoppers. With a market cap of $5.03 billion, the company is led by CEO David Bortolussi.

CLSA downgraded A2 Milk to SELL from Underperform on 28 November, analyst Richard Barwick leaving his price target at $6.

Goldman Sachs added the company to its coverage list on 8 September, analyst Sophie Carran awarding a SELL rating and a $5.80 price target.

Bell Potter upgraded A2 Milk to BUY from Hold on 31 August, analyst Jonathan Snape lifting his price target to $6.35 from $4.75.

A2M shares closed at $6.92 on Friday, up just 2% from where they opened at the start of the year. But the stock has gained more than 57% in FY23 so far and has delivered a 31% share price return over 12 months.

The Morningstar perspective

Zooming back out to a macro view, Johannes Faul, a director of equity research at Morningstar Australia, echoes the Woolworths executive’s comments mentioned earlier. He points to the food price inflation figure of 9.1% for the December quarter, which was up from 8.2% in September.

“But so far in January – and bear in mind it’s just a month – food price inflation is gradually coming off. It’s still very elevated, but the rate of inflation is declining,” Faul says.

He explains the major disruptive effect that COVID and pandemic mitigation measures had on consumer staples retailers. For the supermarkets in particular, Faul notes that the pandemic boosted demand – because restaurants were closed during lockdowns and people were forced to buy more grocery items.

This high demand also offset a lot of the cost rises grocery retailers saw during COVID. These costs included the additional cleaning and “greeting” staff, face masks and hand sanitiser dispensers, and delivery drivers.

“High demand helped with top-line growth but volatility in demand also introduces more costs,” Faul says.

“COVID introduced many additional costs and it also brought higher sales. All up, that period was slightly beneficial for the supermarkets."

What’s ahead for the supermarkets in 2023?

“We expect this year’s margins to be down just a notch. It’s not like prices are coming down – it’s not deflation, it’s just that the inflation rate isn’t as high as in the last two quarters,” Faul says.

“High food price inflation generally means expanding margins for supermarkets. That's what we're seeing and what we're expecting.”

While Faul also emphasises that supermarkets’ costs are increasing, especially labour costs, he argues this will be partly offset by disappearing COVID-linked costs. “They’re all going to vanish. They’re not going to have those costs any more in FY23. That’s all super beneficial to margins, as is the top-line inflation,” Faul says.

There are caveats here, including the rising labour costs mentioned above, which Morningstar expects to lift by 5% for supermarkets in 2023. Faul also anticipates a decline in sales volumes, and for a few reasons. These include the normalisation of consumer spending habits, with people eating out more.

Food price rises in the majors may also drive more traffic to the discount grocery retailers such as Aldi. This is something Faul's team has observed in market data from the UK, which suggests that Aldi and Lidl – another German-owned discounter not in Australia – have won market share from the bigger incumbents.

Data as of Dec. 9, 2022 Source: Morningstar estimates

Faul expects that, if Woolworths and Coles maintain their profit margins, they will see earnings growth in the “mid-single digits” in 2023.

“The question then is, for companies with relatively muted earnings growth outlooks, does a yield of around 3% still look attractive? Investors might want a higher yield from these staples,” he says.

Morningstar forecasts a yield of 3.7% and 2.8% for Coles and Woolworths, respectively, in 2023.

His pick of the staples: Endeavour Group

Faul singles out Endeavour Group, which closed at $6.80 on Friday, slightly above his $6.40 Fair Value Estimate. “On a forced ranking, it’s the most attractive on a price-to-fair value basis,” he says. Morningstar also regards Endeavour as holding a Wide Moat – a measure of the unique competitive advantages held by companies within its research coverage.