Supermarket inflation has peaked and will fade across the year and into 2024. We lower our recommendation to Hold as consumers tighten their belts.
Coles’ third quarter supermarket performance was all about price with volume growth almost negligible. With inflation still a key feature of the sector, COL delivered comparable store sales growth of 6.5%, ahead of consensus 5.6%.
Supermarket sales increased 8.2% (excluding tobacco) in the quarter. Gross supermarket sales increased 7.9% compared to industry growth around 7.1%. Volume growth appeared to be around 0.3% on a quarterly basis but may have gone backwards on a 4-year basis. Packaged goods inflation eased back to 7.2% in 3Q23 compared to 7.9% in the second quarter. Fresh produce inflation was 4.1% (7.1% in 2Q23) as lettuce, cucumber and carrot prices fell. Stronger farmgate milk prices for farmers has kept dairy prices higher. Red meat prices are now falling after a couple of years of higher prices. Soft commodity prices are also falling.
Cost inflation in wages and supply chain is adding to costs for suppliers who are still asking for price increases from the supermarkets although this is reducing in intensity.
COL currently has 841 supermarket stores. The network is now being served by the first of two Automated Distribution Centres which commenced operations in Brisbane in March. The NSW ADC at Kemps Creek is slated for start-up in 4Q24. Including the major automation projects, FY23 capex is still expected to be between $1.2-1.4bn. This will push up annual depreciation and amortisation charges in the income statement towards $1.55bn in FY23 for the continuing operations.
Liquor sales returned to growth of 1.5% on a comparable store basis in the quarter after the previous two quarter were negative. COL has 941 stores in its network. Much of the growth was in eCommerce sales which represent 5.4% of total liquor sales.
The sale of the Coles Express business to Viva Energy is almost complete and should finalise in May.
The recent acquisition of two milk processing facilities for $105m secures the supply of COL’s own-brand milk.
Investment View
Lower inflation will see lower sales growth for COL (and WOW) and this will continue through into 2024. Against this, the prospect of persistent wage inflation provides a note of caution.
COL’s liquor sales growth appears to be below industry growth, and this will provide another challenge for incoming CEO Leah Weckert as she assumes the top job from Monday.
Relative to WOW, we think COL is more fairly valued, but given our view that inflation has now peaked, we have tempered our outlook on the stock. Most of the benefit of higher inflation in the last six months has now found its way into the share price.
Risks to Investment View
If inflation persists at higher levels, sales growth could be better than expected. This will depend on consumer spending patterns, driven by the pressure of higher interest rates. The supermarket industry remains rational, but any change could cause competitors to respond. Wage restraint would also ease the pressure on margins.
Recommendation
We have lowered our recommendation from Buy to Hold.
Figure 1: QUARTERLY SALES
