A Win-Win For Coles And Viva Energy?

Australia | Sep 27 2022

This story features VIVA ENERGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: VEA

Following Viva Energy's purchase of convenience stores from Coles Group, brokers highlight mutual benefits for both companies. 

-Viva Energy acquires 710 convenience stores from Coles Group
-The timing of the transaction proved sooner than expected 
-No material changes to broker target prices
-Transaction may benefit both companies in the longer term

By Mark Woodruff

Viva Energy ((VEA)) will become Australia’s largest operator of fuel and convenience sites following the acquisition of 710 Coles Express sites from Coles Group ((COL)).

While the retailing capability and associated infrastructure of Coles Express will be transferred to Viva Energy and operated as a separate business unit, both companies have committed to a continuation of existing loyalty programs and supply of Coles products.

Viva Energy will use cash and available debt facilities to outlay around -$143m (the headline cost is -$300m), once exiting arrangements and expected working capital benefits are taken into account.

Management forecasts transaction and integration costs of -$120-$140m over the next three years largely for a refresh and rebrand of the stores plus expenditure on technology and digital. Overall, $59m in working capital synergies are expected.

As part of the deal, Coles will also transfer leases worth $816m to Viva Energy. 

The timing of the transaction was the main surprise for brokers, given Viva Energy has already publicly stated an intention to expand its convenience offering and not extend its Alliance agreement with Coles Group beyond 2029.

Ord Minnett sees additional flexibility for Viva Energy from a strategic and operational standpoint and estimates the deal, to be completed in the first half of 2023, will be accretive to earnings and value.

For Coles Group, the broker points out the convenience business represents just 3% of the Coles group valuation and the divestment will be -2.6% dilutive to the broker’s FY24 EPS forecast.  

In reaction to the joint announcement, the average target price set by brokers for Coles Group in the FNArena database falls to $18.45 from $18.73, while the target for Viva Energy rises to $3.28 from $3.24.

The average targets suggest 10.7% and 25.7% respective upside to the latest share prices for Coles Group and Viva Energy.

Jarden, not one of the seven brokers updated daily in the FNArena database, lowers its target for Neutral-rated Coles Group to $17.50 from $18.20, though the adjustment also incorporates softer group sales into forecasts. This follows a softer-than-expected update from Woolworths Group ((WOW)) for the first seven weeks of the new financial year.

However, in a potential win-win scenario, certain longer-term benefits may accrue to both Coles Group and Viva Energy.

Potential upsides for both parties from bringing forward the sale transaction

Credit Suisse is not certain the incremental earnings benefit out to 2029 from the acquisition by Viva Energy will cover the cash outlay, but notes a benefit of sole ownership.

After 2030, the broker’s modelling suggests the demand for traditional fuel retail will diminish at an accelerating rate and the Express network will need to be adapted accordingly.

While having full control of the network is positive for Viva to meet this challenge, the analyst would like some colour from management on whether more or less capital will be needed to invest in the network.

UBS also sees potential for the inclusion of Quick Service Restaurants and/or hub opportunities for last-mile delivery (i.e. smart lockers). Such add-ons may mitigate stranding risk as electric vehicle penetration increases.

Barrenjoey, also not one of the seven brokers updated daily in the FNArena database, notes the risk to Viva has now been removed of Coles under-investing in the network ahead of the Alliance deal ending in 2029. The broker retains its Neutral rating and $2.88 price target.

From the perspective of Coles Group, UBS feels the decision to terminate the Alliance deal indicates declining confidence in both the convenience options and a fuel volume recovery (which is currently lagging expectations).

Once the deal is completed, Coles receives its cash proceeds and transfers $816m of lease liabilities to Viva Energy, Morgans anticipates significant balance sheet capacity for an increased focus on the core Supermarkets and Liquor businesses, which is sorely needed in a time of heightened competition and inflation.

Citi agrees with Morgans the sale makes strategic sense and feels an under-geared balance sheet on sale completion will be utilised to accelerate store renewals and omni channel capability. Any significant capital management initiatives are less likely given the current payout ratio of 80-90% is considered quite high.

Investment in an enhanced store renewal program could even lead to a resurgence in like-for-like sales as occurred in the 2011-16 period, suggests Citi.

Macquarie retains its Outperform rating for Coles and appears somewhat relieved by the transaction, describing the Petrol station business as underperforming and the $300m sale price as underwhelming.

According to Overweight-rated Barrenjoey (target $21), the Coles convenience business struggled as it sought to maximise margin which conflicted with fuel supplier Viva's interest to grow volumes. 

While not the primary reason for the transaction, a by-product of the sale is improved sustainability credentials for Coles Group from the elimination of fuel sales, notes Credit Suisse.

The FNArena database has five broker Buy ratings (or equivalent) and one Hold for Viva Energy, while three brokers have a Buy (or equivalent) for Coles Group, along with two Holds and one Lighten rating.

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