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Sales Growth Likely To Slow For Coles

Australia | Oct 16 2018

This story features WESFARMERS LIMITED, and other companies. For more info SHARE ANALYSIS: WES

Brokers welcome the strongest price inflation in ten years at Coles in the September quarter, although sales growth is expected to slow to more modest levels going forward.

-Little Shop a key success but provides limited operating leverage
-Fresh food inflation could signal upside if trends continue
-Fuel volumes remain a challenge for the convenience business

 

By Eva Brocklehurst

Ahead of the shareholder vote on the planned de-merger, Wesfarmers ((WES)) delivered an upbeat sales report from Coles for the September quarter. The supermarket chain has benefited from the Little Shop campaign, a delayed exit of single-use plastic bags and rising inflation in fresh goods.

Food like-for-like sales grew 5.1% in the September quarter while liquor sales rose 1.3%. Convenience store sales grew 3.4% although fuel volumes declined. Sales were always going to be strong, Deutsche Bank suggests, noting the CEO of Coles has signalled the trend will moderate towards levels experienced at the end of the fourth quarter of FY18.

This is consistent with the broker's channel checks which indicate that post the Little Shop promotion, sales at Coles have slowed while Woolworths ((WOW)) has accelerated, albeit not back to where it was in June.

Little Shop was clearly a success, Citi agrees, in terms of driving sales momentum, but this provides limited operating leverage versus when sales are generated organically. The broker assumes incremental supplier support offset half of the Coles investment.

Other brokers agree that sales should moderate, given lost traffic after the Little Shop promotion, partly offset by higher inflation. Inflation is the main positive UBS draws from the result and believes this signals upside for the supermarket if trends continue.

Inflation was at its strongest in 10 years, up 0.6% in the quarter because of supply-side pressures as a result of the drought. The higher cost of grain and lower supply of livestock affected bakery and meat while fresh produce costs also rose.

Citi agrees inflation is a welcome shift from prior years when retailers expected suppliers to offset cost pressure with efficiencies. This is viewed as further evidence a more rational grocery market is evolving through the Coles de-merger process.

Excluding fresh and tobacco, prices fell -0.8% as Coles continued to invest in its customer. Morgans believes that, given one-off impacts from Little Shop and Flybuys promotions, food and liquor sales growth will slow in the future and forecasts first half sales growth of 3.5%, with 2.2% in the second half.

In-store execution is the largest issue for Coles, Citi asserts, and will require further investment. As a result, Woolworths is forecast to outperform on sales growth over the next 18 months. The broker also observes a reduction in the depth of promotions at both Coles and Woolworths in the September quarter.

Cost pressures are ramping up, stemming from the enterprise bargaining agreement implemented in April, investment in service following the removal of single-use plastic bags and investment in Flybuys. Ord Minnett, on the other hand, is confident the momentum and undemanding comparables will mean food like-for-like sales growth at Coles exceeds Woolworths in the second quarter.

Morgan Stanley expects price-based competition will become less intense with Coles as a standalone company, and the business should continue to move away from deep discounts. Competition should centre increasingly around in-store execution, loyalty programs and new products.

Fuel

Meanwhile, fuel volumes continue to decline and remain a challenge for the convenience business. Like-for-like fuel volumes were down -15.9% because of a substantial increase in fuel costs caused by higher oil prices and a lower Australian dollar, as well as the impact of changes to the commercial terms of the alliance with Viva Energy ((VEA)).

This is a concern for Morgans, as there is no clear turnaround strategy from Coles management and volumes are expected to decline for the foreseeable future. Macquarie also notes Coles has been losing market share because of its uncompetitive fuel supply agreement, yet management has suggested month on month this is less significant.

Petrol volumes have held up in absolute terms over the past 12 months, Citi points out and, while higher petrol prices affect all operators, agrees Coles is at a disadvantage because of the unfavourable terms with Viva Energy.

Road Ahead

Citi believes Wesfarmers is approaching fair value and upgrades to Neutral from Sell, although retains a preference for Woolworths heading into the Coles de-merger. Wesfarmers shareholders are due to vote on the de-merger at the AGM on November 15. If approved, Coles will begin trading as a separately listed entity November 21.

Morgans values Coles on an enterprise value basis of $15.9-17.3bn, based on an FY19 enterprise value/operating earnings (EBIT) multiple of 11-12x and broadly in line with global supermarket peers. The broker suggests Coles should trade at a discount to Woolworths because of a smaller store network and lower earnings margins.

FNArena's database has six Hold ratings and one Sell (Morgan Stanley) for Wesfarmers. The consensus target is $47.88, suggesting 0.5% upside to the last share price.

See also, Outlook For Separated Coles Not Without Risk on Oct 8, 2018.

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VEA WES WOW

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