Price Check!

Ord Minnett has initiated coverage of Coles Group – which rejoined the ASX boards on 21 November – with a Hold recommendation and a target price of $13.25.

 

The food retail industry is improving and for Coles we see the following investment drivers: 1) food earnings growth opportunities due to weak comparable numbers, fresh market share headroom and supply chain cost savings; 2) capital expenditure being well funded despite supply chain investment; and 3) continuing liquor earnings growth despite structural flaws.

 

We also note the potential risks, including: 1) the Fresh Tomorrow strategy is broad, yet tweaks are required, with private-label growth unproven and online margins dilutive; 2) cost savings are long-dated and structural challenges remain, and so inflation is required to support earnings growth; 3) fuel volumes and prices continue to decline, resulting in lower convenience earnings; and 4) management is inexperienced in the role and the listed company environment.

 

Capital expenditure can be well funded and liquor earnings growth should remain strong off a low base. Significant cost savings are long-dated, however, requiring food inflation to drive food earnings growth, while convenience earnings continue to decline given fuel pricing and volume declines.

 

This outlook provides an earnings stream that is somewhat defensive – but not as defensive as peer Woolworths (WOW, Hold) – and valuation support is not compelling, with the stock trading on high-teens forward price to earnings (P/E) multiples with a sub-5% dividend yield. We note, however, that the challenges facing Coles are largely well known.

 

The current management team at Coles is largely new with little experience in a listed company environment, which we suggest could add greater scrutiny and pressure.

 

We initiate coverage of Coles at Hold, noting more clarity on the food strategy with evidence that it can achieve above-market growth, and the resolution of convenience earnings declines, as potential catalysts.

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