Coles Unloads Risk With Pub Deal

Australia | Mar 06 2019

Brokers welcome the decision by Coles to transfer its hotel operations to Australian Venue Company, while retaining earnings from its liquor stores.

-Coles is expected to invest the proceeds in its digital offering and refurbishments
-Positive outlook for groceries but company-specific issues prevail
-Will Woolworths follow suit?


By Eva Brocklehurst

Coles ((COL)) has unloaded the social and intangible risks in its hotels business, undertaking a joint venture with Australian Venue Company. The profit from around 87 hotels (76 in Queensland, seven in South Australia and four in Western Australia) will be received by AVC, while earnings from liquor stores (243 in Queensland, 10 in South and Western Australia) will stay with Coles.

Coles will receive around $200m cash in the transaction and the deal satisfies liquor laws in Queensland, because to obtain a liquor license for a retail shop in that state, the owner must already hold a commercial hotel licence within 10km. This made it difficult for Coles to operate retail liquor shops without having to operate hotels. The structure of the JV is designed with the Queensland laws in mind, because of the weighting of the business to that state.

Management has also previously expressed a desire to exit the hotels business as these activities are considered non-core. Subject to satisfying certain conditions, including obtaining the consent of several landlords, the transaction is expected to be finalised by June.

The deal makes sense to UBS because it allows Coles to focus on its food & liquor business. The main question for the broker is: what will Coles do with the proceeds? Capital management and acquisitions are considered unlikely. Instead, Coles is expected to use the proceeds to improve its distribution centre, digital offering and refurbishments, areas brokers consider were under-invested.

The deal is estimated to be broadly neutral for earnings per share. The pubs business generated around $13m in earnings and around $300m in revenue in 2018. There will be no impact on property ownership, as all pub sites are leased, or on existing liquor earnings.

UBS may be more positive about the grocery sector, amid an expected lift in market growth in FY19/20 of more than 4%, but still believes Coles will face company-specific issues in the near term. This relates to strengthening its competitive long-term position, which will cost money and take time.

Deutsche Bank agrees Coles has a lot of work to do, yet is positive about the deal because it separates Coles from the operation of pubs, which reduces its social and reputation risk. It also removes the company's economic exposure to an industry with regulatory risk. The broker perceives the hotel assets are now under the control of an operator that can extract more value. Using the extra capital to fund investment in supermarkets also gets a tick from Deutsche Bank.

The broker would like to consider the stock more positively following its de-rating but, with costs growing faster than sales, margin dilution will be difficult to avoid, while cycling the boost from the Little Shop promotion will make matters worse.

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