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Food price inflation: Are Coles and WOW shares overvalued?

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The high price of food is lifting the supermarkets but it doesn't mean they are a buy.

Australians are seeing food price inflation. However, experts disagree on whether it will have a long-term benefit on Woolworths or Coles share prices.

In its latest recommendation, Morningstar rates both of the big 2 supermarkets as a sell. This is not because it won't cash in on rising food prices.

Morningstar's director Johannes Faul said that consumers will likely feel the pinch from rising groceries, but demand will remain high due to them being a necessity in everyday life.

"Our analysis dating back 30 years found no meaningful short-term relationship between changes in food prices and changes in food consumption," Faul says.

He even suggests that rising costs will be good for the supermarkets' profits.

"Rather, we anticipate consumers will reallocate money to consumer staples and away from discretionary spending on fashion, electronics and home improvement," Faul continues.

"Higher prices combined with steady demand are likely to underpin top-line growth for supermarkets, despite some offset from consumers switching to cheaper products."

This follows on from a previous investment note by Morningstar where Faul said rising inflation will have fleeting benefits to the supermarkets.

So why did it get a sell rating?

A positive outlook for Woolworths and Coles does not make it a strong buy according to Morningstar.

Simply put, it's all down to valuation.

At the time of writing, Woolworth's share price was $37.32 while Coles was at $18.81.

Even with strong food price inflation, Morningstar opines Woolworths fair value is $29.62 and for Coles it's $15.88.

"Current share prices suggest that the market is more optimistic on the profit outlook for Woolworths and Coles," he said.

The investors believe that this should not be the case over the longer term.

"However, we expect structural challenges to limit their sales and earnings growth at around 4% over the next decade," Faul said.

"We anticipate competition between Australia's supermarket chains including Aldi to remain intense and the quickly expanding and expensive online channels of the majors to add more costs."

Although at their current value, Faul believes that Coles is the better value supermarket.

Goldman Sachs disagrees

The experts over at Goldman Sachs disagree, adding a buy recommendation to both Woolworths while remaining neutral on Coles in its latest recommendations.

Goldman Sachs analysts said that the company retained a buy rating and a $40.50 target price for the supermarket giant.

Last month, the analysts said they were neutral on Coles, with a buy price of $17.20.

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