Coles Group: The devil is in the detail

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Alex Lu
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By Alex Lu
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Date posted:
07 February 2020, 2:09 PM
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  • COL’s 1H20 sales performance was better-than-expected with all divisions delivering solid growth.
  • In addition, COL advised that its provisional 1H20 EBIT is expected to be between A$710-730m. While guidance was above our original A$689m forecast, EBIT was boosted by A$48m in non-operating earnings. Adjusting for these items, COL’s operating EBIT (at the midpoint) was ~2% below our expectations.
  • We increase FY20F EBIT by 2% to A$1,340m.
  • Our target price rises (Morgans clients can login to view detailed reports and price targets) but with a 12-month forecast TSR of -11%, we downgrade our rating on COL to Reduce (from Hold).

1H20 sales performance was better than expected

COL provided a trading update ahead of its 1H20 result with Christmas sales exceeding expectations. Management advised in October that Supermarkets LFL sales growth in the early part of 2Q20 had trended towards the level achieved in 4Q19 (ie. 2.2%).

However, solid Christmas trading pushed 2Q20 LFL sales growth to 3.6%, which was above our 2.3% forecast. The sales performance of Liquor and Express was also better than we expected, with 2Q20 Liquor LFL sales increasing 2.1% (vs Morgans +1.1%) and Express (c-store) sales up 5.1% (vs Morgans +0.6%).

EBIT upgrade driven by non-operating items

In addition to the sales update, COL advised that its provisional 1H20 EBIT (pre-AASB16, on a retail calendar basis) is expected to be between A$710-730m (vs Morgans A$689m).

The provisional result however includes A$48m in favourable non-operating items (A$15m self-insurance release of the workers compensation provision and A$33m in property earnings).

We had forecast EBIT from non-operating items of only A$6m in 1H20 so adjusting for these items, the result (at the midpoint) would have been below expectations.

Supermarkets 1H20 earnings up, Liquor down

On a divisional basis, Supermarkets EBIT growth in 1H20 benefitted from the cycling of higher costs in the pcp related to the removal of plastic bags and increased flybuys promotions.

Liquor EBIT however was lower (vs Morgans +3.7%) due to margin pressure and clearance and promotional activity following the commencement of range reviews.

No earnings detail was provided for the Express segment.

Move to Reduce rating (from Hold)

While at the headline level it looked like a good 1H20 result ahead of expectations, after delving into the detail the EBIT upgrade was driven by favourable movements in nonoperating earnings (which are difficult to forecast).

Adjusting for these, the operating result (at the midpoint) was ~2% weaker than we expected. Following changes to earnings forecasts (FY20F EBIT increases by 2% to A$1,340m) our equally-blended (DCF, SOTP, PE) target price rises (Morgans clients can login to view detailed reports and price targets).

COL is now trading on 24.9x FY20F PE and 3.4% yield. Given the weak operating result we find it hard to justify the stretched valuation and hence downgrade our rating to Reduce (from Hold). COL is due to report its 1H20 result on 18 February.

More information

Morgans clients can login to view our detailed report on Coles Group. Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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