So far, as inflation heads higher in Australia, there has been little impact on volumes given strong household finances. Coles reported an increase in quarterly sales largely driven by higher food inflation, but market share has slipped on fewer store openings.
Australia’s media is obsessed by the swift rise in inflation, magnified by the Federal election. But a certain amount of inflation is generally good for retailers as it can lead to revenue growth if consumers are not dissuaded from their usual grocery spend.
Anecdotally, we understand there has been little impact on volumes due to inflation and even as this persists for the rest of the year, we think household finances are good enough to withstand the changes. Higher interest rates (mortgages) and other price hikes such as petrol may have something to say about that though.
COL’s volume growth did slow in 3Q22 to 0.6% from 1.8% in 2Q22 but this was more likely due to households eating out more and a higher baseline set over the last two years. Average annual volume growth at COL over the last two years is very similar to pre-pandemic growth.
One issue that is hindering volume growth is a shortage of goods on shelves. COL said gaps on shelves were double the normal rate and inbound deliveries from suppliers were only two-thirds on time and in full. The impact on shoppers is not directly measurable as customers can switch brands or stores but this issue will eventually recover.
COL reported comparable store growth in supermarkets of 3.9%, ahead of the 1.5% recorded in 1H22. COL reported inflation of 3.3% (based on its own methodology) which was the main element of the sales growth.
We anticipate there is a tailwind to packaged grocery inflation given input cost increases that could push it towards 5%. This would be the limit to which we think inflation has a positive effect on revenue growth without hurting volume growth.
COL has been disciplined in shutting underperforming stores, but conversely, new store openings have been disrupted by COVID-19. COL’s total sales growth of 4.2% in 3Q22 compares with likely industry growth of 4.7% suggesting that COL has lost some market share. We expect this to recover, potentially from 1Q23f onwards.
The liquor business in COL has been performing well with comparable sales growth of 2.8%. But major rival, Endeavour Group, has outpaced Coles Liquor on a three year period on comparable sales growth. COL has transformed its liquor business with product and range rationalisation, but it has higher operating costs than EDV.
Consequently, EDV has a 20% sales per square metre advantage. That leaves COL with plenty of room for improvement in liquor retailing.
Investment view
Inflation is highly topical at the moment, but it is likely benefitting COL at least until it hits around 5%. Most households have plenty of savings but may begin to cut back on volumes if price increases get too sharp.
COL is trading at a lower PE ratio than WOW with a similar growth outlook.
Risks to investment view
Competition, inflation, general cost growth and further COVID disruptions all present risks to COL’s earnings profile.
Recommendation
We have retained our Hold recommendation.
