COLES has vowed to defend its share of the $90 billion grocery market by doubling its investment in food prices, taking the industry-wide cost of the escalating price war to almost $1 billion.
Wesfarmers' earnings engine room invested about $100 million into grocery prices in the September quarter - double its investment in the September quarter last year - sending prices falling by 1.3 per cent, or almost 2 per cent excluding tobacco. It is the steepest deflation for two years.
Wesfarmers managing director Richard Goyder and finance director Terry Bowen said Coles was prepared to invest a similar amount in the next few quarters, depending on commodity prices, to maintain its price competitiveness and build trust with consumers.
This would take Coles' annual investment to $400 million, compared to the $500 million-plus Woolworths is investing in prices and service in an attempt to "neutralise" Coles, "contain" Aldi and regain lost market share.
"When we took over in 2007 the prices at Coles were more expensive than Woolworths. We had to fix that," Mr Goyder said on Thursday after releasing better than expected first-quarter retail sales.
"They know when they walk into Coles they'll get good value day in and day out...we'll double up on looking to give them more and better value to reinforce that perception," he said.
Coles has "permanently" reduced the price of about 2500 grocery staples under its Every Day Value campaign and the depth and frequency of promotions has increased, with suppliers funding some of the discounts to protect their brands from private label incursion.
The investment has paid off. Coles gained market share, lifting same-store food and liquor sales by 3.6 per cent and total sales by 4.7 per cent to $7.6 billion in the three months ended September 30, exceeding market growth of about 2.8 per cent.
Coles' performance highlights the challenge ahead for Woolworths, which is still larger than Coles but has been expanding at a slower rate since 2009.
Woolworths has invested more than $200 million into prices since February, but its same-store food and liquor sales are expected to fall at least 0.5 per cent in the September quarter, after sliding 0.9 per cent in the June quarter.
Mr Goyder said Coles had "maintained" its price position against Woolworths and its sales momentum at the end of the quarter was "stronger than when we started".
"Customers know very quickly if your specials look good but you're increasing your background pricing. They know very quickly if their weekly shop is costing them more. You can't muck around with your customers on that front," he said.
Analysts said Coles' latest results were in line with forecasts, but escalating price investment was likely to put pressure on margins, because both retailers were prepared to invest ahead of cost savings.
"I'm of the view price competition will continue to increase this year, so there will be margin pressure all around," Credit Suisse analyst Grant Saligari said.
Wesfarmers' total retail sales rose 4.6 per cent to $14.23 billion in the quarter, slightly ahead of market forecasts, and would have been about 2 percentage points higher if not for falling petrol prices.
Mr Goyder said the solid gains reflected a rebound in consumer sentiment as house prices rose, fuel prices fell and stability returned to Canberra.
"I would say there's probably a more optimistic tone around the place at the moment. Whether that continues time will tell," he said.
He urged Prime Minister Malcolm Turnbull to pursue reforms in tax, superannuation and infrastructure and welcomed the government's fresh response to the Harper review, although he remained convinced the introduction of an effects test could have "unintended consequences" on competition.
Wesfarmers is relying on earnings growth from its retail operations to counter a sharp drop in coal prices and weakness in its industrial units in 2015.
Bunnings increased its 18 per cent share of the $45 billion home improvement market, lifting same-store sales by 8.2 per cent and total sales by 11.6 per cent to $2.5 billion, adding to the pressure on Woolworths' loss-making Masters chain.
Kmart was also a standout, with same-store sales rising 8.6 per cent and total sales 12.5 per cent to $1.1 billion, after the chain dropped prices across its range.
Target returned to growth for the first time in years, with same-store sales rising 3.2 per cent and total sales 3.1 per cent to $776 million, as customers responded favourably to price reductions and a new store format.
Kmart and Target are both benefiting from better seasonal conditions and supply-chain problems at Woolworths' Big W, where same-store sales are tipped to fall 8 per cent in the September quarter.
"There's not been the level of markdowns we saw a year ago. Last year there were 75 per cent off sales everywhere," Mr Bowen said.
Citigroup analyst Craig Woolford said the latest results were impressive, particularly at Bunnings and Kmart.
"The macro-economic backdrop is conducive to good sales and Wesfarmers management team are executing well," Mr Woolford said.
