Coles Group is Australia’s second-largest supermarket chain, whose retail offerings included fresh food, groceries, general merchandise, liquor, fuel and financial services through its store network and online platforms. The value gap between Australia’s two largest supermarket operators has been dramatically closing over the space of a week, following their first-half FY24 results. However, both defensive plays screen as overvalued. Given prevailing high interest rates, we believe the market underestimates the risk of relatively low-growth, defensive yield stocks, like Coles and Woolworths, derating. Supermarket sales growth at Woolworths, Coles’ larger rival, decelerated meaningfully to the low single digits in the initial weeks of the second half on a year ago, and CEO Brad Banducci announced his impending retirement.
However, Coles’ supermarkets are maintaining sales growth in the mid-single digits at the start of the second half. We are reluctant to extrapolate the differential in sales growth of the two supermarket chains over a relatively short time period, but we expect any prolonged trading underperformance to trigger a competitive response from Woolworths, with more discounting potentially hurting the bottom lines of both players. From FY25, we expect Coles and Woolworths to maintain their respective market shares and increase their Australian grocery sales in line with industry growth of 4% per year. Coles’ first-half sales and earnings are tracking our FY24 estimates, and our forecast is virtually unchanged. We lift our fair value estimate for Coles by 3% to $15 per share solely due to the time value of money.