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Better March Qtr But Coles Still Underwhelms

Australia | Apr 30 2019

This story features COLES GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: COL

Supermarket sales growth for Coles is expected to decelerate in the next couple of quarters as gains from its collectables campaign lose momentum.

-Downside risk from having to cycle Little Shop campaign in the Sept quarter
-Cost pressures in the fresh category supported price inflation
-Management acknowledges Coles is underperforming in convenience

 

By Eva Brocklehurst

Sales momentum is expected to slow for Coles ((COL)) in the next couple of quarters as the comparable impetus from a successful promotional campaign last year is felt, and costs rise. The company has indicated sales growth of around 1.5% is likely in the June quarter, returning to similar levels as in December. For UBS, this implies a significant deceleration in real growth.

Like-for-like sales growth for the company's supermarkets was 2.2% in the March quarter. The Fresh Stikeez promotion boosted basket size, while food inflation supported sales growth. Deutsche Bank notes the uplift from the Stikeez promotion was smaller than that of Little Shop, and driven by basket size rather than transaction growth. This indicates there may not be much of a competitive impact on rival Woolworths ((WOW)).

There is now the downside risk of having to cycle a successful Little Shop campaign in the September quarter. UBS asserts the outlook is now much softer, which supports its Sell rating. While market growth has improved, promotional intensity is down.

Cost Growth

Deutsche Bank is disappointed because in the absence of promotion incentives, the natural sales growth of Coles is tracking well below cost growth. Food inflation is expected to continue building, which should benefit all operators, but Coles needs to provide signs that sales can exceed costs growth before the broker is comfortable about buying the stock.

Cost pressures in the fresh category supported price inflation of 0.9% for the quarter, with drought conditions and the Queensland cyclone having an impact. Yet, when tobacco and fresh food prices are excluded, prices declined -0.9%.

The company is facing specific pressures and strengthening its competitive position will cost money and take time, UBS assesses, calculating Coles trades at an earnings to enterprise value discount -6% to Woolworths, which does not reflect the upside in the near term for Woolworths and the risk to Coles. Credit Suisse prefers Woolworths because it is more advanced in its supply chain initiatives that should bring a competitive advantage.

Citi stands out, with a much more positive outlook for Coles, noting that the rate of overall sales growth in the March quarter was almost twice that of the prior quarter, largely because of higher inflation in fresh food and the timing of New Year's Eve, as well as online growth of 27%.

Underlying trends are considered positive, with better transaction growth expected from big basket shoppers. The broker acknowledges trading conditions in April are difficult to analyse because of the timing of Easter and school holidays.

UBS notes deflation in dry grocery was partially a result of strong private-label growth and inflation is likely to emerge in this category, given it has appeared in fresh food. However, Credit Suisse is not inclined to read too much into this trend outside of price/volume elasticity. Underlying deflation has been at a similar rate for more than 12 months and there has been no acceleration in branded inflation.

Convenience Underwhelms

Coles Express sales fell -32.4%, predominantly because of changes to the terms of the alliance agreement with Viva Energy ((VEA)). Lower sales in convenience stem from lower fuel transactions and softer tobacco growth. The new alliance came into effect on March 1 and Macquarie suspects the slump in headline fuel volumes, down -10.9% in the quarter, should start to turn around as retail fuel prices normalise.

Management has acknowledged that Coles is underperforming in convenience and intends to improve its performance through new store formats and a dedicated merchandise team.

Like-for-like sales growth in liquor of 0.9% was weaker than Citi expected, as wine market conditions remain challenging and there was reduced promotional intensity in beer. The broker notes store conversions are driving growth in an otherwise tough market.

FNArena's database shows one Buy (Citi), four Hold and three Sell ratings. The consensus target is $12.00, suggesting -5.4% downside to the last share price.

See also, Benefits Of Coles Online Move Uncertain on March 28 and Coles Unloads Risk With Pub Deal on March 6, 2019.

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