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Coles splits from Wesfarmers

Maureen Jordan
Tuesday, October 16, 2018

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As Wesfarmers moves towards demerging its supermarket division, Coles will be a standalone company for the first time in a decade. According to IBISWorld analyst, Tom Youl “the new entity will struggle to fend for itself against its competitors, if it doesn’t keep up with the momentum of recent successes like The Little Shop campaign, and the newly demerged Coles will have to capitalise on the momentum gained via this campaign to gain ground on industry leader Woolworths.” 

Interestingly, despite the success of the Little Shop promotion, which saw its sales spike over 5%, the boss of Coles has said that they won’t be continuing with this innovation.

In case you missed it, here’s an explanation of what lies ahead for this WA-headquartered company.

“The demerger comes after Wesfarmers recently announced it was seeking faster growth among its other divisions, such as Bunnings and Officeworks, hoping that the break away from the capital-hungry Coles will allow them to seek more aggressive expansion strategies. If all goes according to plan, Wesfarmers should retain 15% ownership of Coles, which is expected to be listed on the ASX in late November,” Youl said.

This selling off of Coles comes at a time when competition is rising and the Germans are coming!

“Coles has been a significant cash generator for Wesfarmers over the past decade but has begun to stagnate, losing market share to Woolworths over the past three years. To regain lost ground and prepare for incoming threats, AmazonFresh and Kaufland, Coles is expected to invest heavily in capital over the next five years,” Youl maintained.  

And don’t forget, the other German, Aldi, has been making great inroads into our shopping habits, for example, did you know Aldi is the greatest seller of snow gear in this country?

The new Coles entity will likely operate with three main divisions: supermarkets, liquor and convenience.

“The Convenience division has declined over the past five years as a change to the commercial arrangement with petroleum supplier, Viva Energy, reduced Coles’ fuel revenue. Conversely, the Liquor division, encompassing the company’s liquor retailing and hotel operations, has exceeded expectations and grown strongly over the past five years,” said Youl.  

Despite strong growth over most of the past decade, the performance of Coles’ supermarkets division has been sluggish in recent years.

“At the beginning of the decade, Coles’ price discounting strategy resonated with consumers and division revenue increased sharply. However, Woolworths also invested heavily in price discounting on top of store refurbishments in 2016 and 2017, and has wrestled back most of

the market share initially lost to Coles,” said Youl.  

This also coincided with Woolies appointing Brad Banducci as its new CEO, which has spelt trouble for Coles.

As a result of the split from its parent company, the onus is now on Coles to respond to competing strategies and plans for performance growth. The company has suggested it may invest up to $1 billion in store and on consumer experience upgrades, as well as operating efficiency improvements. Notably, Coles is planning to build two automated distribution centres.

“While this can be seen as a response to Woolworths’ automated warehouse, set to open early 2019, these cost-reduction measures are also in response to industry disruptors, AmazonFresh and Kaufland. These players are expected to offer low prices, further pressuring supermarket profitability,”Youl said.

IBISWorld research has found that The Supermarkets and Grocery Stores industry is expected to turnover $103.4 billion in 2018-19, and grow at an annualised 2% over the next five years.

“While a forecasted rise in disposable income will likely provide opportunities for industry players, Coles must reinvigorate its branding and pricing strategies in order to bring lost foot traffic back to its stores,” Youl said. 

Anyone expecting Coles to be better retail beast after it loses its parent has to factor in how it will be able to compete in a much tougher environment, which will also have Amazon selling stuff that Coles and its rivals currently flog.

Even after the demerger from Wesfarmers, Coles is expected to remain one of the biggest companies in Australia. The company currently employs over 112,000 staff, making it our third-largest employer.  

 

What will Coles do to stand out from the crowd, other than engage in ruinous price competition? The Little Shop campaign actually boosted sales but the new Coles CEO, Steven Cain, who started work last month, said Coles won't repeat the big gain in sales in the December quarter because they won’t sustain the campaign. That implies the cost of the success was clearly too high.

However, there were pay-offs.

“The benefits of the campaign was two-fold, as Woolworths reported a downturn over the same period, with an estimated growth rate of 1.3% compared with 3.1% in the last quarter of 2018. Nevertheless, while the Little Shop campaign has been a success, it remains to be seen if Coles can translate this won battle into winning the war,” said Youl.  

The one interesting lesson for all the competitors in the supermarket space is that there are alternatives to price competition but it requires thinking outside the square and understanding your customers. Who would have thought little plastic versions of Weet-Bix and Vegemite given away when someone spends $30 would work? Someone who understands their customers!

For anyone thinking of investing in the spun off company, here is Paul Rickard’s view, in the Switzer Report yesterday, on Coles going forward.

“Coles will be attractive to investors who want a stock with a higher, fully-franked dividend yield. However, the industry dynamics are against Coles and it is not clear what the path for earnings growth is. Coles will also be facing the prospect of additional capex as it builds its new distribution centres. Those looking to exit their new Coles investment might want to act early.” 

Published: Tuesday, October 16, 2018


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