Australia | Sep 20 2007
By Greg Peel
Everyone knew the Coles (CGJ) result would likely be a shocker, but analysts still weren’t prepared for just how bad it was. The net result was not that far off most marks, but a surprising performance by Kmart (which Credit Suisse goes as far as to call “questionable”) masked a terminally woeful result in Food & Liquor – the bread and butter of the supermarket chain.
F&L earnings fell by 10% in FY07, including a 25% fall in the second half. The earnings margin in the second half was only 2.93% compared to Woolworth’s (WOW) 5.67%. They both sell the same milk and beer. Coles’ operational cash flow fell 27% over the year, and free cash flow after capital expenditure came in at a negative $100m. This for a company that sells weekly groceries, no less.
Merrill Lynch made no bones about it: “Coles is haemorrhaging”.
Merrills doesn’t believe previous earnings are going to provide any guidance for the future. The analysts also hold grave concerns about Coles’ supply chain and IT systems. Automatic replenishment (which, the analysts note, is the “cornerstone” of a retailer’s supply chain) has been delayed again. It has not been lost on most brokers that Woolies is so far up the capex curve that a fight-back from once equal competition would start from a very low base. A smug Woolies is so flush with the spoils that it is now turning to sexing up its retail outlets just to find ways to spend money.
Coles management has said the retailer is entering FY08 with positive momentum. UBS suggests it is “prudent to assume the worst”, which is a nice way of saying “nobody believes you mate”. UBS won’t get any argument from its peers.
The result has been reductions in earnings forecasts from analysts of anything between 4-16%. If it was a dog, you’d shoot it. But then, it really has little to do with results and a lot to do with Wesfarmers (WES) from here on in.
Merrills suggests that if you’re a Wesfarmers shareholder, you too should also be very alarmed. However, brokers all agree that given Coles board approval has already been achieved, the takeover will most likely go ahead. No one else will be interested. The takeover offer pitches Coles at a nice premium (effective $15.44) to where the share price probably should be. The independent expert says it should be worth more, but then even the independent expert may be scratching his head now. Nevertheless, UBS suggests Coles “should be a company transforming acquisition” for WES.
This is the answer to the analysts’ rhetorical question, is Coles a burden or a gift? Despite supposedly picking up the death-bed retailer for a supposed song, there’s going to be a lot of hard work, and a lot of risks, ahead. If you’re a WES shareholder looking for the ultimate turnaround story for Coles under new and more competent management (and let’s face it, they could hardly be worse), then you’d better settle in for the long haul. This could take 4-5 years.
Macquarie, who can’t say much as it’s restricted due to participation in the takeover, notes that Coles FY07 result is not as bad as Woolies’ result in FY88. Does a 20-year old comparison hold water? Well maybe WES shareholders could draw encouragement from Network Seven (SEV), which wallowed for years trying to copy an arrogant Network Nine (PBL – sort of) before finally getting rid of deadwood directors and ultimately slaying the beast. There is no doubt Coles is an “only way is up” proposition, whereas Woolies must be wondering how to do any better from here.
The analysts are all carrying a “Hold” on Coles, as it is in play. Macquarie is restricted, and Merrills has moved to “No Rating” as per its takeover stock policy. The average target price is $15.51, compared to yesterday’s $15.00 close, but that is, again, only a reflection of the WES bid.
Perhaps more relevant is the way the brokers rate WES, which at present is 1/6/3 with an average $40.20 target, smack on yesterday’s close. It will be November before this takeover issue is resolved, so it’s hard to get excited until then, as long as Coles doesn’t disappear out the delivery dock in the meantime.
Boy. Just how happy would you be at KKR right now? It hasn’t been that long since the guys were looking at a takeover at probably $20 or so. And they would never have been able to sell on the debt.