A key consideration for all investors during recessions and boom periods alike is the size of a company's economic moat. In other words, how great is a company's competitive advantage, in terms of its cost base versus rivals, degree of customer loyalty, or other attributes that give it a distinct advantage over its peers.
Clearly, the size of a company's economic moat is highly subjective and, more importantly, can change over time. For example, a number of years ago, supermarket player Woolworths Limited (ASX: WOW) had a fairly robust economic moat. The economy was performing relatively well as a result of a mining boom and shoppers, while conscious of price, were also interested in customer service, convenience and quality. As such, Woolworths appeared to offer its investors a wide economic moat even though there was a degree of competition with its rivals.
However, now that the Aussie economy is enduring a much more uncertain period, consumers are becoming far more price conscious than in previous years. This is causing a price war among supermarkets such as Woolworths, with sales coming under pressure and margins being squeezed. Additionally, the likes of Aldi and Costco, which are no-frills, discount stores, are providing more choice to consumers and appear to be more in-tune with the demands of shoppers during a tough period for families across Australia.
As a result, Woolworths is expected to post a fall in its bottom line of 3.5% per annum during the next two years, as competition increases. This compares unfavourably with the likes of ASX peers such as Ramsay Health Care Limited (ASX: RHC) and Domino's Pizza Enterprises Ltd. (ASX: DMP), with their earnings set to rise at an annualised rate of 19.7% and 28.3% respectively during the same time period.
A key reason for their better growth prospects are wider economic moats. For example, Ramsay is the largest private hospital operator in Australia and so has a dominant position in a market which has high barriers to entry. Furthermore, demand for Ramsay's services is likely to remain high – especially with an ageing population set to demand more healthcare treatment moving forward.
Meanwhile, Domino's enjoys considerable brand loyalty. This has been achieved through making changes to its product so that it is more differentiated from its rivals, in terms of improved ingredients, the use of social media, an easier online ordering system and also greater flexibility in terms of choices of toppings (via its 'create your own' pizza promotion).
Of course, the wider economic moats on offer at Ramsay and Domino's mean that their shares are far more expensive than those of Woolworths. For example, Ramsay and Domino's trade on price to earnings (P/E) ratios of 30.5 and 51.4, versus just 14.1 for Woolworths. But, with such strong growth prospects over the next couple of years and a far more certain outlook, I would argue that such ratings are a price worth paying.
Certainly, Woolworths remains a great long-term buy, but Ramsay and Domino's seem set to offer substantial outperformance, making them better buys at the present time.
