Coles reported a fairly stable result in what could be characterised as a chaotic period. It has managed its costs well and stabilised market share in supermarkets. Higher food inflation is beginning to feature, and this will push sales up, but cost management generally is now a key factor to watch.
COL reported 1H22 EBIT of $975 million, down 4.4% on the same period last year. The group result was impacted by COVID-19 costs ($150 million), related travel restrictions on Express’ earnings and transformation project costs. This was a tough half and COL has navigated it well.
Coles supermarkets comparable sales growth of 1.5% for the halfyear and market share has been stable or rising for the past nine months. The market has been behaving rationally and given increasing supplier prices, we think COL sales growth will increase in 2H22f. Inflation is expected to accelerate by 150bp in 2H22 and shoppers will already be noticing some sizeable price increases in most goods.
Exceptions to the inflation trend are tobacco prices which are stable, and fruit and vegetable prices are falling due to an abundance of product. These two elements have actually been inflationary over the last three years, but packaged goods will now assume that mantle. Underlying cost growth in supermarkets, which excludes COVID costs and Smarter Selling program costs, is expected to increase by 2.5- 3.5% particularly as wage increases kick in. With just over 15k team members covered by the General Retail Industry Award at COL, employee entitlements is a big factor.
Costs have sprung up in the Liquor division too. The cost of doing business increased 7% in 1H22 compared to sales growth of 2.7%. Additional staff and IT costs are behind this, and cost growth will likely persist in 2H22f. Coles Liquor online sales penetration is 5% of total sales compared to 11% at Endeavour.
COL has reduced its FY22f capex guidance to $1.0-1.2 billion but this is primarily due to delays in equipment and staff to complete projects including the Witron automated DCs and the Ocado CFCs (Sydney and Melbourne).
Investment view
COVID costs may be lingering, but the bigger concern for earnings now is the sudden emergence of rapid inflation and rising costs. Supermarket operators will not admit they are partial to a spot of inflation to help push sales along and so far, COL is doing a jolly good job of controlling cost growth where it can. The market perhaps underappreciates COL compared to WOW given the constant PE ratio discount.
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.
