Coles Comeback

Wesfarmers’ Coles business delivered its first-quarter FY19 sales update. Food like-for-like (LFL) sales growth of 5.1% was ahead of our 4.0% estimate, having benefited from undemanding comparable numbers, the Little Shop campaign, the delayed exit of single-use plastic bags and improved execution, along with rising fresh inflation – albeit a greater boost for Woolworths (WOW, Hold).


We are confident a combination of momentum and undemanding comparables should see Coles’ food LFL sales growth exceed Woolworths in second-quarter FY19. Fuel volumes continue to decline and remain a challenge for the convenience business.


Wesfarmers has also released formal documentation for the proposed spin-off of Coles in November 2018. A shareholder vote will be held on 15 November, with Coles shares to begin trading on the ASX on 21 November.


Coles will develop two new automated distribution centres over a five-year period, while closing some existing distribution centres. The move towards supply chain modernisation is pleasing, in our view, although capital expenditure disclosure is limited. Coles’ capital structure could fund gross capital expenditure of about $1bn, removing a key area of concern.


The industry outlook is positive and new CEO Steven Cain is confident of the team in place despite high-profile changes. We maintain our Hold recommendation on Wesfarmers and our $50.00 target price, with our investment view underpinned by the following key factors:


  • Bunnings faces tough comparable numbers and a difficult external environment, yet we forecast a moderation in growth rather than a collapse in earnings before interest and tax (EBIT).
  • Coles’ LFL sales are improving due to better execution, amplified by weak comparables.
  • Department stores are performing much better than expected, with a significant EBIT recovery for Target, while Kmart continues to grow well.
  • Industrials are improving, with chemicals, energy and fertilisers EBIT higher than expected despite medium-term risk in the Western Australia explosive-grade ammonium nitrate business as the Burrup plant comes online.
  • We see valuation support due to lower capital expenditure, an improved business mix supporting a higher P/E multiple, and the prospect of capital management after the Coles demerger following recent divestments.

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