Can Coles’ earnings survive the ethics reprimand?

John Durie
JANUARY 20, 2015
THE AUSTRALIAN
WESFARMERS chairman Bob Every and chief Richard Goyder have so far survived any market fallout from the Coles supplier snafu, which attracted extraordinarily vehement criticism from the Federal Court.
Coles is one of Wesfarmers’ success stories, 21 straight quarters of same-store sales increases ahead of bigger rival Woolworths and on any reading the company has had a huge impact on competition in the grocery market.
Last December Coles was fined $10 million for several serious admitted breaches of the Competition and Consumer Act.
That sort of money for a company which last year reported a profit of $2.7 billion on $62.3bn in revenues is hardly meaningful and the reaction by many in the financial markets is the issue has been dealt with. What does it mean for future earnings? The market judgment is not much but that remains to be seen and to some extent is beside the point.
Goyder led the campaign last year for no changes to the abuse-of-market-power provision, section 46, a defence which, in the light of recent events and admitted behaviour, looks almost laughable.
Wesfarmers last year celebrated its centenary and rightly revelled in its glorious history and commitment to good governance and sustainable business prac­tices, which don’t sit well with the admitted behaviour at Coles.
When the board meets ahead of the February 19 results release the issue and the response to date should be on the agenda.
Former Coles boss Ian McLeod is now an internal adviser to the company but present boss John Durkan was merchandise manager at the time, and responsible for supplier relationships.
If nothing else, the parent company board led by Every must surely now be asking more questions and keeping a close eye on the work of assigned arbiter Jeff Kennett in sorting through specific supplier complaints and relationships in general.
The ACCC acknowledged that Coles had taken steps to address the failures that led to these contraventions, including (1) “A best-practice compliance framework and additional training to ensure Coles’ suppliers are treated in an open and fair manner”.
There is also a supplier charter, which sets out public commitments made by Coles on how it will deal with suppliers, and a dispute resolution framework.
Still, certainly up to 2011 this was more than an inadvertent mistake that all big companies, like any individual, are prone to make and demands a fuller response from Wesfarmers than the Coles confessions to date.
Half a dozen of those involved no longer work at Coles, others have moved into different jobs and those at the coalface now are working within strict guidelines.
Company reaction to such judgments fall into set pieces, noting the events took place a long time ago and all has changed — different from the initial reaction, which was more along the lines that the regulator had gone a step too far.
The sharemarket is meant to be the great predictor of earnings so a scathing judgment from judge Michelle Gordon in the Federal Court and a de minimus fine in December will hardly rattle the cages in the short-term.
It should within the Wesfarmers boardroom, and you can’t help wondering if BAML analyst David Errington was correct in last year’s note, warning that the ACCC focus on supplier relations would add to pressure and dampen margin expansion in the future.
The Errington thesis is that both Coles and Woolies have been able to grow earnings through a transfer of wealth from suppliers to the behemoth retailers.
Certainly supplier margins have fallen at a time Coles’ earnings to sales margins rose from 3.4 per cent in 2008 to 5 per cent in 2013; while Woolies expanded from 6.3 to 7.6 per cent over the same period. He argues the ACCC spotlight will act against the wealth transfer by putting earnings growth under pressure.
Just how badly Coles mistreated some suppliers was laid out for all to see in last month’s court judgment, and it’s hard to imagine Judge Gordon’s words went unnoticed at board level.
She noted “Coles’ practices, plans and instructions were deliberate, orchestrated and relentless.
“The contraventions also showed a failure of Coles’ internal compliance systems and processes, which had the potential to impact a number of suppliers with whom representatives of Coles had dealings,” Justice Gordon said.
She added “Coles’ misconduct was serious, deliberate and repeated. Coles misused its substantial bargaining power.” Its conduct was “not done in good conscience; this merits severe penalty”.
Justice Gordon said “but for Coles making the admissions it has now made and acknowledging the gravity of its contravening conduct, the conduct and circumstances in which it was committed would have warranted imposing penalties at or close to the maximum the law permits”.
She added: “The ACCC now holds the view that Coles has accepted, at the most senior level of its business, that the conduct (in) the subject of the contraventions was unacceptable and that there is genuine contrition at that level of the company regarding Coles’ treatment of its smaller suppliers.”
That acceptance was crucial to Coles getting away with such a small fine. But the change in business practices expected will take more than a few words from the top brass at Coles, and time will tell whether the change in ethics within the division can be achieved while maintaining sustainable earnings growth.