Australia | Apr 30 2021
This story features COLES GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: COL
Is the worst of the pandemic behind Coles now, signalled by several features of shopping behaviour that are starting to normalise?
-May and June likely to be challenging
-Concerns over a price war appear overdone
-Is valuation becoming attractive?
By Eva Brocklehurst
The outlook may be improving for Coles ((COL)) as shoppers return to malls and CBD stores, although supermarket like-for-like sales fell -6.4% in the March quarter as elevated sales from the start of the pandemic were cycled.
Online sales rose 49% and now represent 5.5% of supermarket sales and, as Macquarie points out, the company experienced transaction growth for the first time in a year, amid increased expenditure on baked goods, drinks and confectionery.
In April, supermarket sales rose 4% and the company is notably growing its own brand is a point of differentiation, with penetration now at 31.6%.
The shift towards localised shopping that disproportionately benefited Woolworths ((WOW)) and the independent supermarkets in the first half appears to be unwinding. Management has observed Coles is experiencing improved transaction growth and a recovery in impulse purchases.
Sunday is returning as the busiest day of the week and customers are going back to shopping centres and CBD stores. Morgans finds this encouraging, given the share loss that Coles experienced from the trend to shop close to home in the first half.
Credit Suisse upgrades to Outperform, on the back of a normalisation of consumer shopping. While the supermarket result was below forecasts and there was little change in trend sales growth, the broker takes heart in management's commentary that behaviour is returning to normal.
Citi believes like-for-like sales are likely to remain volatile as the pandemic is cycled but upgrades to Buy as well, to reflect more typical earnings multiples and sales growth. The broker suggests the underperformance of Coles supermarkets relative to the broader market troughed in the March quarter and a strong April is likely to be enough to drive a flat fourth quarter result.
Macquarie posits May and June will be more challenging for comparables as this was the period in 2020 when lockdowns were at their height and abnormal at-home consumption trends commenced.
Fixed costs have fallen from -$30m at the height of the pandemic to between -$3-4m per month currently and Citi calculates -$110m in cost reductions in the second half. This should, in turn, provide a much-needed buffer to a forecast -2.8% decline in second half sales.
Goldman Sachs was disappointed with the comparable growth but believes the update has a positive aspect in terms of the trends and longer-term supply chain efficiency. An implied two-year compound growth rate of 2.9% is expected to continue into the end of the fourth quarter.
Are concerns regarding market share and a price war overdone? The two main drivers of underperformance, in Morgan Stanley's view, included the under-representation of Coles in neighbourhood/local stores, which has been exacerbated by weaker online growth, and expectations of a price war stemming from the re-launched ' down down' campaign.
Management has indicated the return of this campaign is more about marketing than a planned change in pricing strategy, hence Morgan Stanley does not believe this is the start of a price war. Jarden agrees, noting management remains comfortable about relative pricing and, as a result, a price war instigated by Coles is unlikely.
Macquarie points out Coles has recorded price deflation of -0.2%, the first quarterly deflation since FY18, and this is largely a result of promotional activity during the pandemic and the impact of bushfires in the prior corresponding period.
Credit Suisse maintains a two-year cumulative growth rate forecast for supermarkets of 8% and notes inflation has normalised to a two-year cumulative rate of around 1% and believes Coles still needs to improve its price position and overly narrow range in some categories.
Morgans asserts Coles is a well-managed business with defensive characteristics and a strong balance sheet. Valuation is attractive, particularly as the store network continues to benefit from the unwinding of the local shopping trend.
Citi believes the de-rating following the first half result reflected the risk of price competition increasing but continues to find the grocery industry rational along with potential for better long-term profitability.
Could the current discount to the market and Woolworths be an opportunity for investors? Citi believes so, as the valuation gap is likely to narrow in line with the narrowing of sales growth differentials.
Morgan Stanley finds value in the stock as it is trading on 20x FY22 estimates for earnings per share, a -30% discount to the industrials ex-financials index.
Jarden also finds the share price underperformance a reason to upgrade, to Neutral from Underweight, believing the negatives are now being priced in. Yet, the business is still underperforming online compared with Woolworths and there is a need to increase investment in loyalty, stores and supply chain.
All up, Jarden believes the outlook for grocery sector profitability is favourable, although Coles is the least preferred in the sector as Woolworths has a catalyst in the proposed Endeavour de-merger and capital management potential.
Among the stockbrokers that are not monitored daily on the FNArena database, Goldman Sachs has a Buy rating and $20.50 target while Jarden has Neutral with a $17.50 target. The database has four Buy and three Hold ratings and the consensus target is $18.03, suggesting 10% upside to the last share price.
Note: Much of the above was confirmed yesterday, regarding the Woolies v. Coles battle, as Woolworths posted a March quarter sales update that disappointed. However brokers suggest the weak share price response was more about prior valuation than the sales numbers specifically, given they were better than Coles', and continue to see the eventual Endeavour spin-off as a positive catalyst.
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