Coles Group will benefit from the disappearance of the substantial COVID-19 costs it has worn for the past two years. Sales are up, boosted by inflation, but volumes are beginning to slip as customers feel the pinch.
COL’s FY22 EBIT of $1,869 million was almost the same as last year. Sales growth is being propped up by inflation which is showing early signs of volume decay this year.
Supermarket EBIT margin was down 7bp in FY22, helped by unusually low depreciation and lower provisions. Most of the growth in FY23f EBIT will come from the unwinding of COVID-19 costs. The Smarter Selling program saved $230 million in costs during the year but excluding this and the COVID-19 costs still produced cost growth of 7.7% in 2H22. Rising transport and wages costs will see a continuation of this trend.
In 4Q22, COL reported comparable sale growth of 3.7% and inflation increase of 4.3%. This suggests some resistance to price rises is building amongst budget conscious consumers. The volume decline should be modest, but it will limit the comparable stores sales growth in FY23f even as more inflation comes through.
Total COVID-19 costs in FY22 were $240 million compared to $130 million last year. Higher staff absenteeism remains a problem. The pace at which COVID costs unwind in FY23f will be a key factor to watch through the year. 4Q22 COVID costs had dwindled to $26 million so the annualised run rate is already coming down.
The company has seen the cost of its Witron and Ocado capex program increase by $90 million and $185 million respectively. The Witron automated DC project is now expected to cost approximately $1.040 million over the 4½ year build. The Ocado CFC (customer fulfilment centre) program is now expected to cost approximately $330 million. Net EBIT benefits from Witron are expected to commence from FY25f and sales benefits from Ocado in FY24f. Group capex in FY23f is expected to be within the range of $1.2-1.4 billion.
Investment view
We expect the unwind of COVID-19 costs to contribute most of the earnings growth in FY23f and will help to lift margins.
The benefits of higher inflation were evident for COL in 2H22 revenue, although there were signs that customers were ‘trading down’ which could feature more heavily throughout FY23f.
Customers are feeling the bite of inflation. COL said significantly more customers are buying $1 pasta and the $1 coffee at Coles Express has never been more popular.
As cost of living pressures mount, particularly from power bills and mortgage increases, consumers could once again return to making meals at home (bangers and mash, yum) rather than eating out. Unlike the pantry stocking during the pandemic, this could be more frequent trips to the supermarket on a week to week basis.
COL contends that inflation is neutral for supermarkets but the evidence of 2H22 refutes this. Inflation was rising and so was gross margin. The benefit of inflation depends on consumer willingness to accept price increases and what competitor prices are doing. Currently, both factors are favourable for profitability, but if inflation reaches say 6-10%, the situation will likely change.
Risks to 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.
Recommendation
We have retained our Hold recommendation.
FIGURE 1: FY22 RESULT
