Coles Earnings: Wage Hikes, Easing Inflation, and Shoplifting Spell Trouble for Near-Term Margins

We slightly increase our fair value estimate on no-moat Coles COL by 3% to AUD 14.50, mostly reflecting the time value of money. Our sales and earnings estimates remain largely unchanged following broadly in-line fiscal 2023 results. We expect soft earnings growth from ongoing operations in the near term due to weak volume growth, declining shelf price inflation, and labour costs rising ahead of sales growth—together resulting in operating deleverage. So far in fiscal 2024, volume growth has only been modestly positive. And in the June quarter of 2023, shelf price inflation continued to ease, to 5.8% from 6.2% in the March quarter of 2023. Nevertheless, Coles expects tailwinds to support its food and liquor sales in fiscal 2024, including above-average population growth, improved product availability, and a shift to more at-home meal preparation from eating out—a reversal of recent trends management is beginning to see.

The consumer is clearly hurting, especially young families and Coles’ customers aged under 34 years. Shoppers are cutting back on a wide range of discretionary items from hairdressers and beauty services to entertainment and gifts. Hard times are also motivating more shoplifting—a global, industrywide phenomenon. Total loss, which includes theft and waste, is up some 20% on fiscal 2022. Management stopped short of quantitative detail, but we estimate the impact on EBIT margins in isolation could be up to 50 basis points, on a total EBIT margin of 5%.

Wages are on the rise. They are playing catch-up with the prior year’s consumer price index increases and Coles’ hourly wages are due to increase by 5.75% in fiscal 2024—plus an annual Victorian payroll tax increase of AUD 20 million. We forecast fiscal 2024 supermarket sales to increase by 5% on a 52-week basis, and supermarket EBIT margins to decline by 10 basis points to 4.7%.