EUR 850.00 For Business Accounts Only

Morningstar | Wesfarmers Sends Coles Off on a High Note; FVE Unchanged at AUD 39

Wesfarmers was a proud parent, releasing a stellar final report card before sending Coles out to fend for itself. Comparable like-for-like sales increased by a strong 5.1% in the first quarter of fiscal 2019, on the back of the successful "Little Shop" campaign, the most successful short-term campaign in the supermarket’s history. Food sales growth was the highest it had been in 11 quarters and underpinned by larger baskets and more transactions, but management cautioned that sales momentum was unlikely to linger and toned down the implications of the strong quarterly sales for full-year earnings. We reiterate our AUD 39.00 fair value estimate for narrow-moat-rated Wesfarmers, and our estimates are unchanged. Shares screen as overvalued at current prices.

In the second quarter, we expect like-for-like sales growth to slow to similar levels posted in fourth-quarter fiscal 2018 of around 2%, as we anticipate that consumers lured into stores with plastic toys are unlikely to be very sticky and refocus on price, range, and service. Although not quantified, costs increased in the first quarter due to the switch to reusable bags, higher wages, and investments in the flybuys loyalty programme, likely offsetting much of the operating leverage we’d expect from total food sales growing by 5.8%. We forecast EBIT margins for Coles supermarkets to improve slightly, by about 10 basis points, to 4% in fiscal 2019.

The read-through for Woolworths' food business is negative but not unexpected. In August 2018, we highlighted that Woolworths' like-for-like food sales had been slowing since the second quarter of fiscal 2018, hitting a 21-month low in the first seven weeks of fiscal 2019. We estimated Woolworths' like-for-like food sales growth was lower than Coles' in the first quarter, but anticipated sales growth to rebound from there. Longer term, we expect Coles' and Woolworths' grocery sales to grow in line with the Australian food retailing market, at around 4% per year.

In liquor, Woolworths' number-one position remains undisputed. Coles' liquor business grew by 1.3% in the first quarter of fiscal 2019, but this growth rate pales against Woolworths' 3.6% in fiscal 2018, underpinned by the very successful Dan Murphy's big-box liquor format. We still project Coles’ headline food and liquor sales to grow by 2.7% in fiscal 2019.

Turning to Coles' problem child, the convenience business increased like-for-like sales including fuel by 2.5%, but comparable fuel volumes declined by 15.9% to stabilise at around 65 million litres per week. Relatively high crude prices certainly have an impact on demand, but while negotiations with its partner Viva Energy are ongoing, Coles' fuel prices remain on the expense side and stifle traffic to its pumps. Within the Coles group, we estimate that convenience grows at the slowest rate of all the divisions, at just 1% in fiscal 2019, but the segment only accounts for some 10% of group EBIT.