Coles' first net profit falls 29pc after restructuring, demerger costs

Sue Mitchell
Feb 19, 2019
AFR
New Coles chief executive Steven Cain has flagged a “reset” of strategy to set the newly demerged​ retailer up for sustainable long-term growth.
Unveiling a slightly weaker-than-expected first-half result, Mr Cain said Coles had achieved unprecedented earnings growth over the last eight years under Wesfarmers’ control, but now faced challenges such as rising labour, energy and delivery costs, which were growing faster than sales, and changing consumer shopping habits.
Coles was also losing market share in NSW, particularly in wealthier suburbs, discounting was eroding customer trust and store refurbishments were delivering varied results.
Coles CEO Steven Cain said the result was a solid outcome in a challenging retail environment, but has flagged a strategy reset. Wayne Taylor
“It’s time to reset the Coles business to achieve sustainable long-term growth for our shareholders, a strategic refresh to ensure we appropriately address the headwinds facing the company,” Mr Cain told analysts on Tuesday.
Mr Cain, who took the helm in September and promised no immediate changes to strategy, said the revised plan would focus on improving Coles’ fresh food range, making life easier for customers, doubling down on costs, investing in automation and digital to simplify processes, and working with suppliers to ensure sustainable local sourcing.
He gave no guidance for 2019 but said costs were still rising and overall sales momentum was broadly in line with that in the December quarter, when same-store food sales rose about 1.5 per cent.
“What we’ve said is long-term sustainable growth – that’s certainly not short term but we want to try to get there as fast as we possibly can,” he said. Coles will hold an investor strategy update in mid-June.
Coles’ earning rose 125 per cent between 2009 and 2016 but have fallen 19 per cent over the last two years and analysts are forecasting an 11 per cent fall in earnings before interest and tax to around $1.25 billion this year.
By 12.00am AEDT, Coles shares were down 2.8 per cent at $12.23 after falling to $12.10.
Citigroup analyst Bryan Raymond said the share price was likely to remain soft until the strategy update, when investors would gain more clarity about whether Coles would also reset earnings.
(Woolworths’ supermarket earnings fell 37 per cent between 2016 and 2018 after Woolworths reset profits by investing more than $1 billion into prices and service to regain market share from Coles).
In the meantime, Coles shareholders were likely to focus on slowing sales momentum in supermarkets, Mr Raymond said.
Profit falls
Coles listed as a standalone company in November after a $20 billion demerger from Wesfarmers. It was the first time Coles traded as a standalone company since 1985, when G.J. Coles and Coy merged with the Myer Emporium and the group changed its name to Coles Myer in 1986.
Coles’ net profit fell 29.4 per cent to $381 million in the six months ended December 30 after the retailer booked $146 million in supply chain restructuring charges.
The charges, which relate to Coles’ plans to build two new automated warehouses and close five smaller distribution centres, dragged down earnings from supermarkets, which fell 26.7 per cent to $441 million despite a 3.6 per cent increase in sales to $16.2 billion (on a retail calendar basis).
The result was also marred by a 42.7 per cent fall in earnings from petrol and convenience retailing to $47 million (down 39 per cent to $51 million on a retail calendar basis). This more than offset a 3.7 per cent rise in profits from liquor to $84 million (up 7 per cent to $85 million on retail calendar basis).
Group earnings before interest and tax before significant items fell 5.8 per cent to $733 million because of higher corporate costs associated with the demerger, falling short of consensus forecasts of about $744 million.
EBIT from continuing operations after the restructuring charges fell 27 per cent to $567 million.
Mr Cain said the result was a solid outcome in a challenging retail environment and Coles was now laying the foundations for long term growth, including a $950 million investment in supply chain automation and a new fuel agreement between Coles Express and Viva Energy.
“We have delivered strong cash generation and we have a robust balance sheet which will enable us to reposition the business in the years ahead,” Mr Cain said.
No interim dividend was declared.
Wesfarmers intends to pay an interim dividend in March 2019, which reflects in part Coles’ earnings up to and including the date of the demerger. Coles reconfirmed its target dividend payout ratio of 80 to 90 per cent of earnings post the demerger.
Supermarkets
In supermarkets, earnings before interest and tax before one-off restructuring charges rose 0.4 per cent to $602 million.
Coles posted its 45th consecutive quarter of same-store food sales growth, but momentum slowed dramatically to 1.3 per cent in the December quarter (1.5 per cent adjusted for New Years Eve) from 5.1 per cent in the September quarter as the sugar hit from the Little Shop miniature plastic groceries promotion came to an end and the retailer stopped handing out free plastic bags.
Gross margins rose marginally to 24.1 per cent, due to reduced discounting, and cost of doing business to sales was up 27 basis points to 20.4 per cent, due to higher labour and energy costs and extra expenses switching to the new plastic bag regime.
EBIT margins slipped slightly to 3.7 per cent from 3.8 per cent.
Prices rose 0.5 per cent after falling 1.6 per cent in the year-ago period, boosted by higher produce, meat and bread prices. Excluding fresh food and tobacco, prices fell 0.8 per cent.
Coles said strong growth in average basket size (up 3.1 per cent) was the key driver of sales, largely underpinned by an improvement in items per basket, particularly for larger basket customers.
Transactions grew by 0.5 per cent, but second quarter trading was adversely impacted by performance in New South Wales and unfavourable weather.
Online sales rose more than 30 per cent to around $1.0 billion on a rolling 12 month basis as Coles rolled out Click & Collect, which now represents 30 per cent of online sales.
Coles continued to shift away from high-low promotions towards every day low prices, lifting the number of products on EDLP by 13 per cent to 4,700.
It also added about 200 fresh convenience products to its range in more than 150 stores and added another 700 private label products, boosting own-brand penetration to 29 per cent of sales.
Coles opened 14 supermarkets and refurbished 25, but closed seven stores, taking its network to 816.
Liquor
Liquor earnings rose 7 per cent to $85 million despite lacklustre sales growth of 0.6 per cent to $1.7 billion. This figure includes Coles hotels and gaming operations.
Comparable store sales slipped 0.1 per cent, after growing 1.6 per cent in the year ago period. New Years Eve fell in the third quarter of the financial year compared to the second quarter last year.The second quarter was also impacted by unfavourable weather.
Liquorland was the strongest performer, buoyed by a better range, exclusive brands and more convenient options for customers including Click & Collect and same-day and next-day deliveries.
The First Choice format continued to evolve with 15 First Choice conversions completed during the period. However, trading conditions for Vintage Cellars remained challenging.
Convenience
Convenience and fuel was the biggest disappointment, although the fall in earnings was flagged when Coles announced a new fuel supply deal with Viva earlier this month.
Sales fell 1.8 per cent to $2.9 billion, with lower fuel volumes offsetting convenience store sales growth, and EBIT dropped 39.3 per cent to $51 million as gross margins fell and costs rose.
Coles is forecasting full year earnings of $50 million, implying a small loss in the June-half, compared with $190 million in 2017 and $133 million in 2018.
Coles surprised the market two weeks ago by announcing a new fuel-supply agreement with Viva Energy, which will see earnings from the company’s convenience store division fall sharply.
Under the new deal, which took about two years to negotiate, Coles will take a commission on every litre of fuel sold and will focus on building sales from convenience stores.
Mr Cain has warned the business will barely break even in future if fuel volumes do not improve.
Viva paid Coles $137 million in compensation – equivalent to Coles Express 2018 earnings – to reflect the value transfer.
Coles shares have slipped from $12.75 since listing but are trading above their December low of $11.49.