Woolworths shares tumble to five-month low on margin headwinds and profit downgrade

Woolworths (ASX: WOW) shares tumbled 5.3% in early trade on Wednesday after the supermarket giant downgraded its earnings forecast for the first half of FY25, citing changing consumer spending habits that have led to lower-margin sales.

Woolworths shares briefly returned to year-to-date highs after its FY24 result on 28 August, which revealed solid earnings, better-than-expected cost outcomes, and a special dividend.

The stock is now trading back at five-month lows amid compounding headwinds from the ACCC investigation and today's earnings outlook.

1Q25 results and trading update

The quote: "Customers remain highly value-conscious and continue to purchase more items on special or trade down to lower priced items including Own Brand. These competitive factors together with strong eCommerce growth are leading to a lower margin sales mix which has impacted earnings," said CEO Amanda Bardwell.

Q1 performance

• Group sales up 4.5% year-on-year to $18.0 billion (up 3.3% excluding Petstock)

• Group eCommerce sales up 21.2% to $2.4 billion

• Australian Food sales up 3.8% to $13.5 billion

Disappointing guidance: “While the key Q2 trading period remains ahead of us, Australian Food EBIT for the first half is forecast to be below our previous expectations. We currently expect 1H25 EBIT ... to be within a range of $1,480 million to $1,530 million compared to $1,595 million in 1H24," said Bardwell.

At the midpoint ($1.51 billion), the new guidance represents a 5.6% year-on-year decline in EBIT and 10.4% below consensus expectations of $1.68 billion.

Other key takeaways:

• Wage inflation: Bardwell says "wage cost growth will remain elevated in FY25."

• NPS drops: 1Q25 VOC NPS fell one point to 46 following the announcement of the ACCC's legal proceedings

• Woolworths brands thrive: "Own and exclusive brand sales grew 6.0% in Q1 as customers continued to shift more of their basket to the value offered by Own Brand," the report said.

• Prices moving into disinflation: "Average prices in Q1 declined by 0.3% compared to the prior year. Excluding Fruit & Vegetables and Tobacco, average prices declined by 1.8%."

One step forward, two steps back

Woolworths shares rallied 3.3% following its FY24 earnings report on August 28, which met market expectations. The standout was the Australian Food division's gross margin, which expanded 76 basis points thanks to stronger sales in long-life products and better sourcing arrangements. Early FY25 momentum looked promising, with Australian Food sales up 3% in the first eight weeks, driven by volume growth rather than price increases – a trend that analysts viewed favourably.

At the time, Citi analysts projected further gross margin expansion of 40 basis points in Australian Food for FY25, with most of the gains (55 basis points) expected in the second half of 2024. These improvements were seen as crucial to offset rising costs from the Moorebank distribution centre and higher corporate expenses.

However, today's trading update paints a different picture. While sales growth remains robust, it's coming from an unfavourable shift in consumer behaviour, with customers trading down to lower-margin products. This suggests Citi's projected margin improvements for FY25 are unlikely to materialise.

The next 24 hours will likely bring a wave of broker changes for Woolworths. The key question is the magnitude of these revisions. Citi, for instance, maintained a BUY rating and $39 target price as of August 28. Will they lower the target price while keeping their Buy rating, or opt for a more dramatic shift by downgrading to Neutral alongside a deeper price target cut?