Check Out The Value

Following Coles Group’s first-half FY20 result, and an update on trading to start the third quarter of FY20, Ord Minnett has reviewed its investment thesis for the company. We make the following observations:

 

  • Coles’ food division is showing momentum with a strategy emerging based on cost savings driving service investments, and the tailoring of range and formats to support like-for-like (LFL) sales and margins at the earnings before interest and tax (EBIT) level.

     

  • Competitor Woolworths’ (WOW, not rated) food momentum has slowed and it faces risks due to fewer hours by salaried managers.

     

  • Valuation support now exists, with the gap to Woolworths expected to continue to narrow.

The highlight of the result was food LFL sales growth in 2Q20, which was was better than we had forecast, and the start to 3Q20 has been ahead of both our expectations and Woolworths’ performance. Undemanding comparable numbers and the Fresh Stikeez program provide a near-term tailwind. Positive elements of the food strategy, which we had previously been unable to identify, are now emerging, notably an end to the unsound decisions of previous management, cost savings being achieved and reinvested to improve customer service, and a tailored range and store formats, with these factors all supporting higher food LFL sales growth and EBIT margins.

 

Rational competition is allowing dry grocery inflation and we are now more confident it remains despite a softer performance from Woolworths. The Kaufland exit before opening is another positive, while ‘panic’ buying due to COVID-19 concerns should provide a short-term boost, but is mostly a bring-forward of sales from 4Q20 into 3Q20.

 

We have increased our FY20 and FY21 normalised EPS estimates by 2.6% and 4.3%, respectively, due to higher food LFL sales growth and EBIT margins. Our estimates for the liquor and convenience businesses are unchanged. We recently upgraded our recommendation to Accumulate from Lighten and raised our target price to $16.75 from $15.00.

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