Learn To Invest
Stocks Special Reports LICs Credit Funds ETFs Tools SMSFs
Video Archive Article Archive
News Stocks Special Reports Funds ETFs Features SMSFs Learn


Coles forced to boost spending amid shift to online groceries

Lex Hall  |  22 Jun 2021Text size  Decrease  Increase  |  
Email to Friend

If you want to get an idea of Coles’ scale, consider the following statistics. The supermarket retailer has more than 800 stores, employs about 110,000 people, who process over 20 million individual customer transactions a week from Australia's population of 25 million.

And as far as accessibility goes about 80 per cent of the Australian population is less than a 10-minute drive away from the nearest Coles store.

That sounds like grounds for a narrow moat at least. And yet, Coles Group (ASX: COL), Australia’s second largest retailer, is yet to forge a ten-year competitive advantage in the eyes of Morningstar director and retail analyst Johannes Faul.

A key reason is competition. Despite its reach, Coles, which was spun off from Wesfarmers in late 2018, trails market leader Woolworths. The narrow-moat supermarket leader has more than 1000 stores, almost double the workforce of Coles, and does 10 million more transactions per week.

But there’s another reason why Coles is trailing—and that’s to do with its relatively slow progress in selling groceries on the internet.

Coles used its recent Investor Strategy Day to say that its e-commerce continues to outperform its brick-and-mortar food and liquor sales growth. But the online channel requires more capital to support this growth.

Leading on this front are Woolworths Group (ASX: WOW) and the drinks retailer and hospitality company it recently spun off, Endeavour Group (ASX: EDV), which lists on 24 June.

Investing Compass
Listen to Morningstar Australia's Investing Compass podcast
Take a deep dive into investing concepts, with practical explanations to help you invest confidently.
Investing Compass

“Coles is currently on the back foot in terms of online sales penetration in food and liquor retailing compared with market leaders Woolworths and Endeavour, respectively,” Faul said in an update following the strategy day.

“Coles’ management guided to a significant increase in capital spending in fiscal 2022 and beyond, most of which is earmarked to improve its digital capabilities and to renew its physical stores.”

Coles (COL) v Woolworths - 3YR

a chart showing the Coles share price versus Woolworths over three years

Source: Morningstar Premium; data as of 22 June 2021

At the close on Tuesday, Coles was trading at $16.45, against Faul's fair value estimate of $13, which means it is overvalued by almost 30 per cent.

Faul says Coles has the balance sheet to support its aspirations and maintain its high dividend payout ratio. It has a forward dividend yield of 3.76 per cent. In March this year it paid a fully franked dividend of 33 cents.

“Although we have increased our midcycle net capital expenditure estimate for Coles by almost 50 per cent—with incremental spending averaging some $400 million per year over the next decade—an uplift in our depreciation rate offsets most of the adverse impact on our intrinsic valuation.

“Nevertheless, shares in Coles screen as materially overvalued. All else equal, current shares prices imply operating margins in Coles’ supermarkets segment will expand by about 100 basis points to 5 per cent, compared with our investment thesis of flat EBT margins of 4 per cent long-term. Over the past five years, supermarkets' EBT margins have averaged 4.2 per cent.”

In Australia, consumers still buy virtually all their groceries in-store and Faul expects Australian online grocery sales to remain in the low single digits in the midterm, despite strong online sales growth rates.

Coles leverages its store network as pick-up stations and distribution centres to fulfil online orders. At present, a quarter of orders on Coles' website are click-and-collect, with higher cost delivery orders accounting for the rest of online sales.

Faul says shifts in consumer habits are putting pressure on many traditional brick-and-mortar retailers to increase their spending to protect market share.

“By building an online sales channel in addition to an existing physical store base, the cost base increases, and profit margins weaken unless total sales increase.”

is senior editor for Morningstar Australia

© 2022 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

Email To Friend