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Coles ‘laying foundations’ despite 5.8pc slide in earnings

Glenn Freeman  |  19 Feb 2019Text size  Decrease  Increase  |  
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Ageing supermarkets and a sluggish response to modern shopping habits have led to slow sales growth at Australia's second-largest food retailer.

Coles Group's (ASX: COL) has reported a 5.8 per cent drop in group earnings before interest and tax for first half 2019, in its first set of numbers since splitting from Wesfarmers last November.

Group EBIT fell to $733 million, due to falls in its Coles Express division and rising costs linked to the demerger.

Coles also booked a $950 million investment in automating its distribution centres, in a six-year process management hopes will streamline its supply chain and modernise some of its ageing stores.

Coles Group CEO Steven Cain said the result was a "solid outcome" in a challenging retail environment, and Coles was now laying the foundations for long-term growth.

This is a key part of the result, says Morningstar senior equity analyst, Johannes Faul.

"It shows Coles management feels they have to improve their offering, cost structure and the speed at which they adjust to the retail environment,” Faul says.

"But it makes me wonder why they've left this until now. It points, arguably, to an under-investment in supply chain, so that means more capital expenditure in future."

Coles management highlighted under-performance within its New South Wales stores, which is partially a function of an ageing fleet, Faul says.

The rise of e-commerce technology is also driving the need to change, as is competition from incumbents Woolworths (ASX: WOW) and Aldi, and the impending entry of Amazon Fresh and German budget grocery chain, Kaufland.

Coles

Management highlighted under-performance within its New South Wales stores

"The more players and the more channels you have, the more complex and fast-moving the overall industry will move," Faul says.

Some of the headwinds facing Coles are industry-wide, such as the growth of internet-based sales. This feeds into Coles' rising cost of doing business, which is outstripping its sales growth.

EBIT margins declined 12 basis points during the half, to 3.7 per cent from 3.8 per cent.
This continuous pressure on margins is a key part of Morningstar's thesis, for both Coles and Woolworths.

Faul also notes the failure of promotions such as the Little Shop campaign - miniature versions of in-store items - to generate long-term customer loyalty. While sales growth was 5.1 per cent in first quarter, this fell to just 1.3 per cent in the second quarter, following the end of the campaign.

On the cost front, Coles management pointed to staffing pressures from a new enterprise bargaining agreement and the introduction of single-use plastic bags.

"I'd also add to that the higher costs of fulfilling online sales," Faul says, which he illustrates using the following example.

"If a customer spends $100 in a Coles store, it recoups about $4 of that. On the same spend in an online order, it makes zero," Faul says. This is because of the higher costs of delivery, including associated fuel and staff costs.

He views this as a reversal of the trend toward self-scanning of goods in stores, which reduces the cost to the business by eliminating cashier staff.

Coles share price was down more than 2.5 per cent to $12.26 at 2:30pm.

is senior editor for Morningstar Australia

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