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Morningstar | Coles Hands Over Its Noncore Gaming Operations. FVE Unchanged at AUD 12.30.

After effectively exiting its fuel retailing business in February 2019, no-moat-rated Coles is further concentrating its portfolio by selling its pub operations. The gaming operations underpinning pub profitability have long been a sore point for Coles’ management, even before the demerger from Wesfarmers. The transaction highlights the increasing focus of both investors and corporates on environmental, social, and governance, or ESG, factors.

Coles found a structure to walk away from gaming, while keeping its off-premise liquor retailing business in Queensland. The state regulator requires liquor stores operate under a pub licence. In a newly created joint venture, or JV, with Australian Venue Co, Coles continues to be the operator and reap the profits generated by its 243 liquor stores in Queensland; while its JV partner will operate the 87 pubs and capture their economic benefits after the deal completes later in fiscal 2019.

The pubs generated pro forma EBIT of AUD 13 million in the 12 months to Dec. 31, 2018, representing less than 1% of total underlying profits for Coles. Australian Venue Co will compensate Coles for the loss of this revenue stream with a one-off payment of AUD 200 million. The sale price equates to an EV/EBIT of 15 and looks attractive against our estimate of Coles’ EV/EBIT of 12. Nevertheless, Coles is selling its pub operations too cheaply when measured against book value, resulting in a loss of AUD 20 million in its fiscal 2019 accounts. We maintain our fair value estimate of AUD 12.30, as aftertax proceeds of AUD 200 million offset the loss of the operating cash flow from the pubs.

Coles is selling a higher-margin business, albeit a small contributor to group earnings. The pubs’ operating margin of 4.3% is some 40 basis points higher than those of the core supermarket and remaining liquor businesses, both at 3.9% estimates.