Coles Not Checking Out

Wesfarmers released its first-quarter FY18 retail sales and resources production report. The results were mixed, with the strong retail divisions of Bunnings Australia & New Zealand (ANZ) and Kmart again performing well, while those that were already challenged – Coles, Target and Bunnings United Kingdom & Ireland (UK&I) – were weak.

 

  • Coles’ slowdown was due to fresh produce deflation as well as poor execution, despite undemanding comparable numbers. Coles Food like-for-like (LFL) sales rose 0.3%, versus our forecast of 0.9%, with deflation higher at 2.3% compared with 0.8% in fourth-quarter FY17.
  • Bunnings ANZ’s LFL sales growth of 10.8%, versus our 9.0% forecast, was another very strong result due to execution and the external environment (including wet weather and the Masters closure). However, Bunnings UK&I disappointed in difficult trading conditions, with LFL sales falling 11.9%, resulting in questions remaining about its path to profitability.
  • For the department stores, Kmart had a strong performance with LFL sales rising 4.9% while Target fell 6.4%, despite tough and easy comparables, respectively.
  • Metallurgical coal production was in line with our forecast, while steaming coal was below expectations.

Wesfarmers is undergoing a significant amount of change, including the appointment of a new chief executive officer, Rob Scott, who replaces the long-serving Richard Goyder, and we make the following points regarding the near-term outlook for the company:

 

  • Coles’ earnings before interest and tax (EBIT) is being rebased as its major competitor Woolworths (WOW, Accumulate) has improved its performance, and it is dealing with difficult comparables following seven years of outperformance. How Coles responds to ceding market leadership in sales growth is of great interest.
  • Bunnings is expected to continue to perform well following industry consolidation and its strong position in ANZ, although UK&I remains a challenge.
  • The outlook for the department stores is varied, with Kmart expected to continue to do well but a replication of the Kmart strategy at Target so far is proving ineffective; we remain concerned both cannot succeed at once.
  • The industrial divisions have improved due to cost savings and better commodity pricing, although metallurgical coal prices have fallen from recent peaks.

We have reduced our normalised EPS forecasts by 0.2% for FY18 and 0.8% for FY19. We maintain our Hold recommendation on Wesfarmers with a $44.00 target price. 

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