Coles Has Stolen The WOW Factor

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By Greg Peel

First quarter like-for-like sales at Coles grew by 6.2% compared to equivalent growth at Woolworths ((WOW)) of 2%. It's the first time Coles has outsold Woolies since Adam went shopping for apples.

Alright apples never actually grew in the Middle East, and there might be some exaggeration here, but the result does represent Coles' largest advantage over its rival in six years. In absolute numbers, Coles sales were $331m compared to Woolies' $291m yet Woolies boasts around 20% more supermarket floor space.

It has thus proven difficult for analysts to be anything but happily surprised by the numbers, and all agree that despite the parent company's diversity, a turnaround for Coles is very much a driving factor for the Wesfarmers ((WES)) share price.

One cannot consider the like-for-like sales to nevertheless be…ahem…“apples to apples”. As Macquarie points out, the two rivals are working off differing comparable numbers and quite frankly revenue is not a viable stand-alone measure of performance. Without openly declaring a “price war”, Coles has been pushing the boundaries on the pricing of staple foods and shoppers have been responding. Coles needs to convert revenue performance into margin growth.

This is where the two differ. Having climbed atop a pile of competitor corpses ahead of and in the exit from the GFC, Woolies has nowhere to go. There is no more upside left for Woolies in the sense of becoming “number one supermarket” without risking throwing good money at peripheral and cosmetic improvements or pursuing some foolish new strategy as some analysts fear it might. Coles, on the other hand, is just getting back on its feet and analysts are expecting margin improvements ahead.

I find it strange that not one analyst made mention of Masterchef. If I had to see Curtis Stone trying to convince us Australia's top chefs buy all there food at the supermarket one more time I would have imploded. And with each of the Masterchef contestants recipes being available the next day at Coles stores, surely some of the sales success can be traced back to a very smart advertising campaign.

But that's Coles. Wesfarmers also owns K-Mart, Target and Bunnings in the retail space and here the results were mixed.

K-Mart had a very good quarter, mostly through driving home its low price strategy. This had a noticeable negative impact on Woolies' rival Big W, but also on Wesfarmers' own Target sales. At the end of the day, the more discretionary side of retailing in Australia is suffering the impact of price deflation (the need to discount to move goods) in the hangover post-stimulus. And for once, the usual star of the Wesfarmers show was also hurting.

Bunnings' sales numbers were weak, but aside from price deflation analysts agree the wet weather across a lot of Australia in the quarter would also have kept the DIYers away in droves. Sales numbers are thus expected to improve in the second quarter, but Bunnings will shortly be running up against competition in the form of Woolies' own push into Hardware Hell.

Outside of retailing, the wet weather also impacted on coal production at Curragh which is a tale of woe now repeated right across the resources sector. Weather aside, slowing production growth at Curragh is also causing some concern among analysts when Wesfarmers is supposed to be a story of “Coles and Coal”. In the latter case, it's all about expectations of rising coal prices.

In terms of broker ratings on Wesfarmers, the only change emanating from the quarterly result was a timid upgrade by Credit Suisse to Neutral from the only previous Sell rating (Underperform) among the FNArena database brokers. CS nevertheless suggests taking profits on the recent WES share price performance given the analysts do not believe such a great Coles/Woolies comparable result will become the norm.

Three other brokers in the database rate WES a Hold on the basis the market is already factoring in a solid turnaround for Coles, while the four Buy ratings are largely set on the back of greater things expected of Coles ahead. The most notable of these is BA-Merrill Lynch which from the outset was the most outspoken anti-Coles advocate amongst all brokers. In August the analysts caved in and upgraded WES straight from Underperform to Buy, and this sales result still has them “dazzled”.

That leaves WES with a 4/4/0 Buy/Hold/Sell ratio in the database with a consensus target of $35.31, suggesting only 4% upside.

Amongst other brokers, Morgan Stanley believes the strong Coles story is actually overshadowing what it perceives as strong headwinds facing the coal business. MS is sticking to an Underweight rating. Commonwealth Bank Research has ridden the Coles wave with a Buy rating but has now pulled back to Hold suggesting the good news is already in the price.

Goldman Sachs, on the other hand, disagrees with Morgan Stanley on coal and is backing Coles with a Buy rating.

The arguments are not very helpful to the no doubt confused investor, but the 4% upside to the consensus target should be suggestion enough that the market is already ascribing quite a lot of success to the Coles phenomenon.

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