Merrill Lynch report warns Woolworths can’t shore up profits by squeezing suppliers any further

Woolworths may be unable to squeeze suppliers any further, putting it at risk of an earnings downgrade, according to a report by Merrill Lynch.

The investment bank has warned that Woolworths’ earnings are under pressure from increased labour, electricity and rent costs, as well as a slowdown in productivity improvements which the retail giant has been offsetting by cutting prices paid to suppliers.

“The risk to food retailers’ gross margins, in particular Woolworths’, is when suppliers can no longer provide improved trading terms – that is, when the well is dry in terms of being able to provide the retailers with increased rebates,” Merrill Lynch analyst David Errington said in the report.

“Our view is that this time is fast approaching, given the parlous financial condition many suppliers are in.”

Errington warned Woolworths could be at risk of an earnings downgrades if margins continued to come under pressure.

Woolworths reported a gross profit margin of 26.6% for the past financial year, up from 26.03% a year earlier.

Merrill Lynch refused to provide a copy of the report to SmartCompany but confirmed the accuracy of excerpts from the report quoted in The Australian today.

“EBIT [earnings before interest and tax] growth is not being driven by a reliance on support from suppliers,” a spokewoman for Woolworths said.

“Improvements in gross profit have come from a range of different factors and initiatives within the business – this includes effectiveness in promotional activity, improved stock management, reduced shrinkage, benefits of direct global sourcing and successful new store formats- in fact, the largest contributor of these in 2011-12 was shrinkage.”

Earlier this year the Australian Food and Grocery Council claimed Woolworths was forcing suppliers to cut prices or their products would be removed from the shelves.

The AFGC claimed Woolworths gave a number of suppliers two weeks to find cost savings of between 5% and 10% or have their products removed from sale.

Both Woolworths and Coles also appeared before a Senate inquiry into food manufacturing in May to defend claims that they were squeezing out suppliers and increasing sales on cheaper private label products at the expense of branded competitors.