Coles Group: Changing with the times

About the author:

Author name:

By Alex Lu

Job title:

Analyst

Date posted:

25 August 2022, 8:00 AM

Sectors Covered:

Industrials

• Coles Group’s (ASX:COL) FY22 result was slightly above expectations.
• Key positive(s): Supermarkets and Liquor earnings were better than expected; Market share improved in 4Q22 as local shopping unwound; Smarter Selling initiatives are on track to reach cumulative benefits of $1bn by the end of FY23.
• Key negative(s): Capex for Witron and Ocado transformation projects have increased vs previous guidance; Group EBIT margin fell 20bp to 4.7% due to cost inflation and investments.
• Management said Supermarkets sales will cycle the lockdowns in 1H22 and price inflation in 2H22, while Liquor will also cycle lockdowns in 1H22.
• FY23-25F underlying EBIT changes by between -2% and 1%.
• Our target price falls to (login to view) and we maintain an Add rating.

Solid FY22 result

FY22 underlying EBIT was flat at $1,869m (+2% vs MorgansF and +1% vs Bloomberg consensus) and underlying NPAT rose 4% to $1,048m (+5% vs MorgansF and +4% vs Bloomberg consensus).

Divisional summary

Supermarkets EBIT rose 1% to $1,715m, which was 2% above our forecast. LFL sales increased 2.6% (FY21: +2.5%) with growth accelerating in 2H22 (+3.8%) on the back of price inflation.

Online sales jumped 41% to $2.8bn with penetration now at 7.9% (FY21: 5.8%). Supermarkets EBIT margin was broadly flat at 5.0%, which was a good effort in our view with higher operating costs (COVID, fuel, Witron and Ocado projects) and digital investments largely offset by Smarter Selling and strategic sourcing benefits.

Liquor EBIT fell 1% to $163m, which was 2% above our forecast. LFL sales rose 2.1% (FY21: +6.3%) with solid trading through the year, particularly in 1H22 during the lockdowns in NSW, VIC and the ACT.

At a category level, Ready-To-Drink and Spirits were the key drivers of growth, which was similar to what Endeavour Group saw in its Retail business. EBIT margin fell 20bp to 4.5% reflecting higher investment and COVID costs, and increased D&A from renewals and new stores.

Express EBIT fell 37% to $42m (-12% vs MorgansF) with convenience LFL sales (-3.9%) adversely impacted by lockdowns in 1H22 and reduced mobility and floods in NSW and QLD in 2H22. LFL fuel volumes were also weaker (-4.7%).

Outlook

COL did not provide a trading update for July and August but noted Supermarket sales for FY23 will be cycling COVID lockdowns in 1H22, and price inflation in 2H22.

In Liquor, management expects sales growth to also be impacted by the cycling of COVID lockdowns in 1H22, while in Express, weekly fuel volumes and sales are expected to benefit from increased mobility.

COL provided an update on the Witron and Ocado transformation projects with total capex now expected to exceed previous guidance. Updated capex is expected to be ~$1,040m for Witron (vs ~$950m previously) and ~$330m for Ocado (vs $130-150m previously).

The increased capex guidance for Witron was on the back of higher inflation and labour costs, while Ocado was largely due to an enhanced customer offer and expanded scope to better meet the ecommerce requirements going forward.

While the cost blowout was disappointing, given higher inflation and a very different ecommerce outlook than pre-COVID, we think the adjustments make sense. As always, the key will be whether the investments will generate the required returns.

Changes to earnings forecasts and investment view

FY23-25F underlying EBIT changes by between -2% and 1% while underlying NPAT changes by between -3% and 1%.

Our equally-blended (DCF, SOTP, PE) target price falls to (login to view).

Trading on 22.6x FY23F PE and 3.6% yield we continue to see COL as offering good value with the company possessing defensive characteristics that should hold up relatively well in a weaker economic environment.

Add rating maintained.

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