Is Woolworths going to put its reputation on the line?
FOR supermarket chains, market clout, fat margins and vertical integration of the supply chain are the Holy Grail.
It is no surprise then that speculation has emerged in the alcohol industry that Woolworths has been in discussions to buy all, or part, of one of the more prominent alcohol companies, Independent Liquor, which sells everything from beer, wine, spirits and lots of ready-to-drink brands (also known as alcopops) to liquor outlets, hotels and clubs.
If the talk is right, it would increase the company's power over the alcohol industry.
In the past few years, retail chains around the world have done a good job of squeezing wine, beer and spirits groups. In Australia, Coles and Woolworths have been no exception. They have screwed them on the price they pay for the various alcohol products, the credit terms they receive and the shelf space they give them, and their foray into private labels is hanging like the Sword of Damocles over many heads.
Consolidation of the alcohol industry has been going on for a few years but not at the same pace as at the supermarket chains. This has created a power imbalance between the two, made worse because consumers are now drinking alcohol in many different forms, by an oversupply of wine and the emergence of private-label brands and boutique beer.
In little more than a decade, Coles - which is now owned by Wesfarmers - and Woolworths have spread their tentacles across the retail spectrum. They run a near-duopoly in the $80 billion grocery industry, with a market share of 70 per cent. They are also among the biggest players in petrol retailing, with a combined share of 44 per cent. And they hold at least 45 per cent of the liquor, clubs and hotels industry and 60.5 per cent of department stores through Big W, Kmart and Target. In hardware, Bunnings already controls 14 per cent of the highly fragmented industry and 56.5 per cent of hardware retailing. Woolworths is the biggest owner of poker machines in the country, operating 12,000 through its Australian Leisure and Hospitality subsidiary.
Moving into wholesale liquor would enhance the company's vertical integration strategy across the supply chain and further increase its clout over the big beer giants. As one observer put it: ''It would take away shelf space for all the brands. It would put downward pressure on all price points and reduce production volume, which means less recovery of production of fixed costs.''
A connection with Independent Liquor would not only give Woolworths internal capabilities to make its own beer, wine and spirits, it would also give it access to about 900 independent retail customers.
But there are several stumbling blocks, including the company's public commitment to responsible drinking.
In its corporate-responsibility report released to the ASX on Tuesday, Woolworths listed its principles concerning alcohol, three of which are listed here:
PRINCIPLE 1 The product should not have the potential to appeal to minors.
PRINCIPLE 2 The product should not have an appearance that could potentially lead to confusion with confectionery or soft drinks.
PRINCIPLE 3 Ready-to-drink products containing more than two standard drinks per single-serve container will not be stocked by Woolworths Liquor Group.
Sticking to just these will be a challenge, given that much of Independent Liquor's earnings are built on ready-to-drink products and high alcohol content, large-format packaging and alcohol, and energy mixers like Pulse.
But does Woolworths really want to own so much ready-to-drink and beer capacity outright? And does it really want to deal with wholesale customers when its speciality is retail?
Independent Liquor has been for sale informally for more than a year. It is owned by two private equity operators, PEP and Unitas, which acquired it three years ago for $NZ1.3 billion, outbidding trade buyers such as Lion Nathan, Diageo, Asahi and Brown Forman.
At least one investment bank has been contacting potential buyers regularly to gauge their interest. To date there has been little, with the culture of the business being an issue, and the price.
The general rule of thumb for private equity operators is to keep an investment for three to five years, squeeze costs, lift revenue and sell for a big profit through a trade sale or float. It is what the private equity operators did with the Myer float, and many before it.
But for PEP and Unitas, the introduction of an alcopops tax slashed its profits, forcing the private equity owners to pump in at least another $50 million in cash to recapitalise the business last year. With earnings down more than 30 per cent, the owners are under water, and for a deal to be brokered they would need to take a big hit.
