Coles Group: COVID experts

About the author:

Alex Lu
Author name:
By Alex Lu
Job title:
Analyst
Date posted:
23 February 2022, 10:00 AM
Sectors Covered:
Industrials

  • Coles Group's (ASX:COL) 1H22 result was broadly in line with expectations, which was a good effort in our view given risks around higher COVID costs that could have materially impacted earnings in the half. 
  • Divisional EBIT: Supermarkets -1% (+1% vs MorgansF), Liquor -5% (-6% vs MorgansF) and Express -63% (-50% vs MorgansF). 
  • COL did not provide sales growth rates for the first few weeks of 2H22 but noted Supermarkets sales were elevated in the early part of January due to the spread of Omicron before moderating later in the month and into February. 
  • We decrease FY22-24F EBIT by 1% in each year. 
  • Our target price falls slightly to (login to view) and we maintain our Add rating. COL remains our key pick in the Supermarkets sector.

1H22 result was largely in line with expectations

1H21 group EBIT fell 4% to A$975m (-1% vs MorgansF and Visible Alpha consensus) while underlying NPAT dropped 2% to A$549m (+1% vs MorgansF and +2% vs Visible Alpha consensus).

We thought the result could have been weaker after Woolworths (WOW) advised in December that direct and indirect (supply chain disruptions) COVID costs have had a negative impact on its 1H22 earnings.

We estimate higher costs will reduce WOW's Australian Food EBIT margin by 70bp, while COL's Supermarkets EBIT margin fell by only 10bp. The cost performance of COL was hence very good with higher COVID costs largely offset by benefits such as Smarter Selling (>$100m), strategic sourcing (particularly Own Brand) and range reviews that introduced new higher margin products. 

Divisional summary

Supermarkets EBIT fell 1% to $896m, which was 1% above our forecast. LFL sales increased 1.5% (1H21: +7.2%) reflecting strong trading over Christmas with customers opting for premium products, and further growth in online. Online sales jumped 46% to $1.5bn with penetration now at 8.2% vs 5.7% in the pcp.

While online margins remain below in-store margins, COL said the channel's contribution to Supermarkets profit increased relative to the pcp. Inflation remains benign with prices falling by 0.2% during the half reflecting higher packaged groceries and meat prices offset by fresh produce (mainly fruit) and tobacco deflation. 

Liquor EBIT decreased 5% to $99m, which was 6% below our forecast. LFL sales rose 1.8% (1H21: +15.1%) driven by strong online sales, particularly at Liquorland. Spirits, ready-to-drink (RTD) and wine were the best performing categories. Investments in the Liquor strategy continued with ongoing store renewals as well as systems, product range and online. These investments contributed to a 40bp fall in EBIT margin, although this was partly offset by improved product mix. 

Express was hit by lockdowns in NSW, VIC and ACT, which negatively impacted forecourt traffic. LFL sales (c-store) fell 7.4% with EBIT decreasing 63% to $12m (-50% vs MorgansF). The business saw an improvement in trading in 2Q22 as restrictions eased. 

Trading conditions remain volatile

COL did not provide sales growth rates for the first few weeks of 2H22 but noted Supermarkets sales were elevated in the early part of January due to the spread of Omicron before moderating later in the month and into February. Management said sales varied significantly between states, store locations and on a week-to-week basis due to COVID and floods in SA, which had an impact on sales (particularly WA). 

For FY22, we forecast Supermarkets EBIT to be down 1% to $1,690m, Liquor EBIT to fall by 3% to $161m and Express EBIT to decline by 28% to $48m.  

Changes to earning forecasts and investment view

We make minor adjustments to earnings forecasts with FY22-24F EBIT reducing by 1% while underlying NPAT decreases by between 0-1%. 

Our equally-blended (DCF, SOTP, PE) target price falls slightly to (login to view) and we maintain our Add rating

Trading on 22.9x FY22F PE and 3.5% yield we continue to see COL as offering good value with the company possessing defensive characteristics and a strong balance sheet (1H22 net cash $54m) allowing ongoing investment for growth. 

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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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