Coles’ Dividend Attraction Meets ACCC Allegation

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New research highlights dividend growth potential for Coles Group as management targets growth initiatives and implements cost-out, but has the ACCC temporarily spoiled this party?

-Cash generation supporting higher dividends at Coles Group
-Earnings upside from growth initiatives and cost-out
-ACCC launches court action for misleading shoppers

By Mark Woodruff

Freshly initiated research by Bell Potter suggests shares in Coles Group ((COL)) are relatively more attractive than key competitor Woolworths Group’s ((WOW)) with high levels of cash generation supporting dividend growth in the years to come.

Since FY20, the board has paid out 81% of cumulative profits and achieved 4.2% per annum growth in dividends after generating earnings at a compound annual growth rate (CAGR) of 3.7% per year over that period.

Bell Potter anticipates growth in both earnings and dividends through to FY27 via business improvement initiatives such as Simplify & Save and delivery of targeted returns on recent capital initiatives, largely around automated distribution and fulfillment centres.

Certainly, Macquarie is expecting these automation investments will yield benefits in FY26.

Following FY24 results in late-August, Ord Minnett noted cash generation was “robust” and likely to continue into FY25, helping support Bell Potter’s growing dividend thesis.

Coles Group retails fresh food, groceries, household goods and liquor through a network of 856 grocery stores and 992 liquor outlets.

The company also has a 50% share in Flybuys rewards with Wesfarmers ((WES)) and a property development arm.

Bell Potter’s initial $21.55 level sits at the top of the target price range of seven covering brokers in the FNArena database and raises the average to $20.11, suggesting around 9.5% upside to the latest share price. Coles shares have come under selling pressure this week following news the  Australian Competition and Consumer Commission (ACCC) is taking both Coles and Woolworths to court for deliberately misleading shoppers.

Allegedly misleading conduct

Since the release of Bell Potter’s initiation, management teams at both Coles and Woolworths have been forced to defend separate proceedings launched by the ACCC.

Each has allegedly breached Australian Consumer Law “by misleading consumers through discount pricing claims on hundreds of common supermarket products”.

The ACCC is not making any allegation of any collusion or anti-competitive conduct by Woolworths and Coles as part of these proceedings.

In the case of Coles Group, the ‘Down Down’ advertising campaign included promotional prices higher than, or the same as, the previous regular price, according to ACCC chair, Gina Cass-Gottlieb.

In a separate statement, management at Coles Group announced it intends to defend the proceedings.

The inherent risk with so many price rises and products on promotion at a major supermarket chain, suggest Evans and Partners, is potential for an issue to occur that is deemed to be false and misleading.

This broker points out the two examples provided by the ACCC both involved a situation where the suppliers requested a price increase. Subsequently, the retail shelf price was raised, and then shortly after Coles inserted the specific product onto a ‘Down Down’ promotion.

Potential fines could be substantial, notes Jarden, with a maximum penalty for each breach the maximum of -$50m or reasonably attributable benefit (or if not determined, 30% of adjusted turnover).

A -$50m penalty for FY25 would have an around -3% impact on pre-tax profit, estimates the broker. Jarden suggests the longer-term financial impact to both Coles and Woolworths will be immaterial.

Goldman Sachs sees a risk around negative consumer sentiment towards the major supermarkets, but believes it is too early to assess potential market share impacts.

Analysts at JP Morgan are more concerned by the “court of public opinion” and remain cautious on the supermarket industry over the next six months as negative headlines will likely continue through the ACCC inquiry as well as the Federal election, weighing on related share prices.

Recent FY24 results

Commenting after consensus-beating FY24 results for Coles in late-August, Ord Minnett attributed the outcome largely to margin expansion amid tight cost control and reduced theft levels.

FY24 earnings (EBIT) of $2,057m came in around 2% above Citi’s forecast (3% ahead of consensus), while the FY25 trading update showed total supermarket sales growth of 3.7%.

This broker forecast 60bps of gross margin improvement in FY25 for Supermarkets, supported by lower loss rates in the first half.

Supermarkets was the strongest segment, noted Ord Minnett, buoyed by an improved theft outcome and the growing Coles 360 media business, as the retailer attempted to ameliorate the impact of tobacco’s declining share of sales.

On the flipside, Liquor suffered a reversal in earnings, hampered by one-off items booked above the line but also by a challenging environment for the alcoholic beverage industry, which was also evident in FY24 results for rival Endeavour Group ((EDV)).

In Liquor, the group has ceded wholesale market share and is being negatively impacted by consumers trading-down for value, explained Macquarie.

While wage growth and fixed cost deleverage (as wholesale volumes dropped) dragged on margins over FY24, this broker expects a recovery in FY25.

Reasons for a rising dividend forecast

Noting the capex peak has passed, Bell Potter forecasts 9.1% per annum compound growth for earnings out to FY27, with this flowing through to growth in dividends.

Management recently guided to $1.2bn in capital expenditure in FY25, comfortably under Ord Minnet’s $1.5bn forecast at the time.

Coles operates in a competitive and mature sector with revenue growth largely a function of inflation and population growth, explained the analysts.

Population growth is the primary structural growth driver of volume, notes Bell Potter, and is forecast to remain at an average of 1.5% per year through to FY28.

The expansion of the store network at a pace consistent with population growth is one of several growth drivers available to management, according to the analysts.

Supplementing population growth, Bell Potter expects an ongoing near-term transition to in-home channels from out-of-home, before a likely recovery uplift in liquor demand across FY26-27 as the benefits of tax cuts and lower interest rates move through to demand for discretionary items.

Beyond this, the broker’s earnings growth forecast for Coles is driven by operational leverage on higher sales, lower loss levels and delivery against recent growth initiatives in automation.

Additionally, management’s Simplify & Save program is targeting $1bn in benefits by FY27, with $238m already delivered in FY24.

Growth initiatives

Bell Potter notes the 1.45bn capital investment program in automated distribution centres (ADC’s) and customer fulfillment centres (CFC’s) will reduce costs and release store capacity.

Using technology from Germany’s Witron logistics group (in partnership with UK e-commerce group Ocado) the program is running ahead of schedule, noted Ord Minnett following FY24 results. It’s felt anticipated benefits will be worth the heavy investment.

The analysts at Morgans cautioned some time will elapse before these facilities reach optimal capacity, but operating leverage should improve as volumes increase.

In July, operations began at CFC’s in NSW and Victoria, which will significantly enhance the Coles online offering by improving order rates, increase freshness and expand the product range, explained Morgans.

Coles remains Citi’s preferred Supermarket given the strong earnings story into FY26 and ongoing cost savings from a yet-to-be-announced third Witron automated distribution centre.

This broker awaits capital management strategy details at the company’s Investor Day on November 14.

Of the seven daily covered brokers in the FNArena database, four have Buy (or equivalent) ratings) for Coles Group and three are on Hold.

Outside of daily coverage, Jarden and Goldman Sachs have Hold ratings with an average target of 16.65.

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