Praemium

Macro Trends

Coles' momentum slows

29 Oct 2013 91 month(s) ago

MomentumColes is slowing, but Bunnings is strong and the coal assets reasonable. That is the confusing picture with the conglomerate Wesfarmers. Brokers are divided, and some are bearish.

MomentumDeutsche Bank has a sell on Wesfarmers, citing signs of slowing momentum in Coles.The Woolworths result is yet to come out, so Deutsche acknowledges it does not know yet if it is because of a weaker economy or a slowing of operational improvements. Deutsche has a price target of $38.50 and has the stock on a forward earnings multiple of 20 times, which is high. The forward dividend yield is 4.5%.

"Coles F&L (food and liquor) was the key disappointment, with the lowest sales growth since FY12. LFL (like for like) sales grew by 3.4% (DBe: 4.25%) and the contribution from new space also missed our expectations.

"Deflation (driven by fresh) contributed to the slowdown and liquor remained a drag. Bunnings was very strong with the best LFL result in over 2 years. Target fared worse than expected with a 5.2% comp decline (DBe: -2.0%). The Kmart result was difficult to interpret given the impact of lay-by sales but was reasonable with underling LFL growth of 2.0%. Coles & Target downgrades largely offset by Bunnings & Resources upgrades Coles and Target sales were weaker than we forecast which prompted earnings reductions for the divisions while Bunnings was stronger than we expected which drove an upward revision to our forecasts.

"We have also moved to revised DB house coal price forecasts which are slightly higher than our previous estimates, resulting in an increase in our earnings estimates for the Resources division. The net result was a negligible change to our overall earnings forecasts for the group. Our $38.50 price target is based on our SoTP valuation (rolled forward at a 9.3% WACC less dividends) which we believe is an appropriate methodology given the number of discrete business units. We value the coal business on an NPV basis. Our valuation has risen as a result of appreciation of the broader market. Risks include: higher Coles margins, or firmer coal prices."

Wesfarmers is a difficult stock to value because it is a conglomerate. Its size suggests risk is low. But the Coles performance is not a cause for enthusiasm. Morgan Stanley, which has an equal wieght recommendation, thinks there is a race to the bottom in the supermarket duopoly:

"Significant fresh food deflation and continued investment in lower prices looks to have driven the step down in prices. Greater price deflation led to slowdown in Coles LFL sales growth to 3.4% (4Q13 4.5%). We think that the acceleration in supermarkets selling area – or the ‘space race’ is also leading to weaker LFL sales outcomes for the Australian supermarket operators."

Volume growth is tracking sideways:

Like for like Food and liquour sales are tracking deflation: