Coles signs new fuel deal with Viva, says convenience earnings will fall 62pc

Sue Mitchell and Angela Macdonald-Smith
Feb 6, 2019
AFR
Analysts have cut profit forecasts for Coles by as much as 10 per cent after the recently floated retailer signed a new fuel supply agreement with Viva Energy which will decimate earnings from petrol and force Coles to ramp up convenience-store sales.
Coles expects earnings from its convenience division to fall to $50 million this year because of falling fuel volumes – compared with $190 million in 2017 and $133 million in 2018 – and managing director Steven Cain warned the business would barely break even in future if fuel volumes did not improve.
Under the 10-year agreement, which was finalised on Wednesday after two years of talks and trials, Viva will set the retail price of fuel, collect the full retail margin and receive higher royalties on Coles Express convenience store sales.
Coles, which previously set the retail price, will take a commission on every litre of fuel sold and will focus on running the convenience stores, increasing its range of ready-made meals, fresh food and coffee and using the 711 sites as pick-up points for Coles Online orders. Coles now has three Coles Express sites that do not sell fuel.
Viva will pay Coles $137 million in compensation next month – equivalent to Coles Express 2018 earnings – to reflect the value transfer.
But analysts warned that Coles’ convenience earnings from 2020 would be a fraction of those in the past and the division would represent only 1 per cent of group earnings compared with about 10 per cent previously.
Earnings hit
Coles shares fell 2.5 per cent to $12.41 and Viva shares jumped 14 per cent to $2.19, reflecting the view that Viva had emerged with the better deal.
“Investors have been expecting some downside to Coles earnings because of its agreement with Viva being recut [but] the magnitude of the earnings hit is a bit of a surprise,” said one analyst, who declined to be named.
“There will be profit downgrades to consensus estimates of between 5 and 10 per cent,” he said.
Viva has been holding Coles over a barrel since 2014, when it bought Shell’s retail fuel and refinery businesses, took over the 11-year-old Coles supply contract and ramped up wholesale prices, forcing Coles to raise pump prices well above those at Woolworths, BP and 7-Eleven to make a decent return.
As a result, over the past three years, Coles’ fuel volumes have fallen from about 100 million litres a week to 62 million litres a week in the December half.
Analysts feared Coles’ loss of market share in fuel and its premium petrol prices would flow through to supermarkets.
Mr Cain, who said in October he was willing to exit the $35 billion retail fuel market to end the deal with Viva, said Coles had finally drawn a line in the sand.
Coles managing director Steven Cain hopes the new deal will boost fuel volumes and convenience earnings. Wayne Taylor
“Fuel volumes have declined significantly and it became obvious to us it wasn’t a sustainable situation,” Mr Cain said. “We see this as a win for Coles customers and also being a good deal for both companies.”
Mr Cain said if Coles and Viva could lift fuel volumes from 62 million litres a week to 75 million and boost convenience-store sales, it expected convenience earnings to be maintained at about $50 million and eventually improve. However, if volumes remained at about 60 million litres a week, the business would just break even.
Viva chief executive Scott Wyatt, who previously blamed Coles for missing forecasts, has pledged to reinvest some of the extra margin into price to boost volumes, a move which could trigger another fuel price war.
“Yes there is a transfer of value from Coles to ourselves but we have made a payment for that in respect of the $137 million that we provide to Coles and we are going to invest a lot of that benefit back into the business to arrest the decline [in volumes], restore growth and move the business forward,” Mr Wyatt said.
However, he said it could take a couple of years to get volumes back up to 70 million to 75 million litres a week and acknowledged that some former customers of the alliance may be hard to win back.
Existing loyalty benefits will continue, including 4¢-a-litre fuel discounts and the ability to earn Flybuys points on fuel and merchandise. Viva will use Flybuys data to contact “dormant” customers with compelling offers to win them back.
Disclosure
Analysts slammed Coles, which listed as a standalone company in November after a $20 billion demerger from Wesfarmers, for not revealing the material drop in first-half and full-year convenience earnings earlier.
“When were you going to inform the market of a material earnings hole?” asked Bank of America Merrill Lynch analyst David Errington.
“There’s a pretty big earnings drop here. You’ve informed the market of a deal [today], not how bad the business has been performing.”
Mr Cain defended the company’s disclosure, saying it had revealed at Wesfarmers’ annual general meeting in November the demerger scheme documents and first-quarter sales results showing fuel volumes continuing to decline.
Coles also revealed the convenience division previously paid an undisclosed $30 million a year brand fee to Coles Supermarkets. After the demerger, this will no longer be payable, boosting convenience earnings but reducing supermarket earnings. The brand fee change was included in the guidance for 2019.
Mr Errington said the deal was “a pretty solid outcome” for Viva, whose shares are trading below their July 2018 $2.50 issue price after a series of downgrades. Viva will get both the wholesale and retail margin on alliance petrol sales and pay an agent’s fee to Coles to operate the sites.
“You have now got yourself quite bit of sugar … to be able to reinvest and get the business humming again,” Mr Errington said.
Coles has also pledged to match dollar-for-dollar every customer donation to Red Cross through Coles checkouts over the next two weeks to help communities affected by natural disasters, including the floods in far north Queensland and bushfires in Tasmania and Victoria.