Coles Group: The cost of doing essential business

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Alex Lu
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By Alex Lu
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Date posted:
20 August 2020, 8:52 AM
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  • Coles Group's (ASX:COL) FY20 result (pre-AASB16) overall was slightly above our expectations. Supermarkets EBIT rose 11% (+2% vs Morgans), Liquor EBIT was flat (+5% vs Morgans) and Express EBIT fell to -A$16m (Morgans -A$22m).
  • Key positives: Strong balance sheet; Good cash flow realisation; Ongoing benefit from increased demand for in-home consumption.
  • Key negatives: Limited operating leverage due to higher incremental costs despite solid sales growth.
  • We increase FY21F underlying EBIT by 30% to A$1,843m largely due to the inclusion of AASB16 related adjustments (or +4% on a LFL pre-AASB16 basis).
  • Our target price rises (Morgans clients can login to view detailed reports and price targets). Hold rating maintained.

FY20 result was slightly above our expectations

COL's FY20 result (pre-AASB16) was slightly above our expectations with underlying EBIT up 5% to A$1,387m (+2% vs Morgans) and underlying NPAT rising 7% to A$951m (+3% vs Morgans).

The result was driven by strong demand for food and liquor products as people increased in-home consumption.

For FY20, Supermarkets LFL sales rose 5.9%, Liquor grew 7.3% and Express (c-store) increased 4.6%.

Online remains strong with sales up 18% for the year.

Despite the solid sales growth, costs remain elevated with COL incurring A$170m in COVID-19 related expenses in 4Q20.

These related to one-off employee payments and discounts as well as extra safety and cleaning costs in store and in distribution centres.

This is limiting the amount of operating leverage in the business with Supermarkets EBIT margin rising by only 14bps in FY20.

COL's balance sheet remains strong with ND/EBITDA (pre-AASB16) at 0.4x and cash realisation was good at 111%.

Total DPS of A57.5cps was broadly in line with our forecast (A57.0cps).

Sales still elevated but costs also remain high

Management advised that Supermarkets LFL sales in the first six weeks of FY21 has been broadly in line with 2H20 growth rates (i.e. +10.0%).

However, elevated costs is resulting in EBIT margin consistent with FY20 levels (i.e. 4.9%).

While ~A$70m of the A$170m in COVID-19 related costs should not recur in FY21, a lot will depend on future demand and social distancing restrictions.

COL has also flagged additional opex in FY22 and FY23 of up to A$75m related to the ramp up of its automated distribution centres (Witron) and online fulfilment centres (Ocado).

Offsetting these costs will be ongoing savings (>A$250m in FY20) from its Smarter Selling program.

Overall, we forecast Supermarkets EBIT margins to be broadly flat over the medium term.

Maintain Hold rating

In our view, COL is a well-managed business with a strong balance sheet and defensive characteristics.

Our equally-blended (DCF, SOTP, PE) target price rises (Morgans clients can login to view detailed reports and price targets) following updates to earnings forecasts and our view that the ongoing uncertainty with COVID-19 will see people continue to spend more time eating and drinking at home.

This should continue to be beneficial for COL in the short. However, trading on 25.3x FY21F PE and 3.3% yield we see these tailwinds as largely reflected in the share price.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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