Coles Group Limited (COL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Coles Group FY '22 Results Announcement. [Operator Instructions] I would now like to hand the conference over to Mr. Steven Cain, CEO. Please go ahead.

Okay. Thank you, and good morning, everyone, and welcome to our 2022 full year results announcement from our Melbourne store Support Center. Joining me on the call this morning are Charlie Elias, our Chief Financial Officer; and a number of our other ELT, including Matt Swindells, our Chief Operations and Sustainability Officer; Leah Weckert, who many of you know, our Chief of Commercial and Express today; Ben Hassing, our eCommerce Chief; and Darren Blackhurst, our Liquor Chief. Just before we start, I'd like to pay an acknowledgment of country. I wish to acknowledge the traditional custodians of this land on which we meet today, the Wurundjeri people of the Kulin Nation. We accept their strength -- or sorry, we acknowledge their strength and resilience and pay our respects to their elders, both past and present. So moving on to Slide 3 of the presentation deck, which hopefully you have in front of you. Just a few things to say here. Our team members, customers and our communities have continued to face a number of significant challenges this year with COVID-19 and flood, and I'd like to thank all of them. Despite this, I'm pleased to say we've been able to successfully execute on the third year of our transformation strategy and deliver a solid result. With families facing increased pressure on the household budgets, our commitment to delivering trusted value remains more important than ever. During the year, we continued to focus on delivering trusted value, innovation and inspiration with more than 1,300 Coles Own Brand and more than 170 exclusive Liquor brand products launched. In eCommerce, we delivered very strong growth with supermarkets, eCommerce sales up 41% and Liquor eCommerce sales up 49%. Significant investments were made during the year in customer experience, capacity and a unified app. We have also recently launched our unified website, but we'll have more to say on this in our Q1 results. We delivered Smarter Selling benefits of approximately $230 million and are on track to deliver the $1 billion of benefits by FY '23 that we promised 3 to 4 years ago. We've also done a lot of work on sustainability, and it's a big focus area for us, as you know. We'll talk more about it later, but possibly the highlight of the year was being ranked by the World Benchmarking Alliance as the second most sustainable supermarket globally. As always, we continue to invest in our team members, which saw a 3% -- point increase in our mysay team member engagement survey and importantly, on the safety and well-being front, 14.7% improvement in TRIFR. Finally, at the group level, we achieved a ROC of 16.4%, invested CapEx of $1.2 billion, focused on growth and efficiency initiatives and declared total FY '22 dividends of $0.63 per share. Moving on to Slide 4. With regards to the financial results, which obviously Charlie will talk to in more detail, total sales up 2% to $39.4 billion. On a 3-year basis, that's 12.4%. EBIT was stable at around $1.9 billion. Our net profit after tax increased by 4% to $1 billion, with the increase driven largely by a reduction in net finance costs compared to the prior corresponding period. Gross operating capital expenditure was $1.2 billion, operating cash flow of $3.6 billion, cash realization of 104%, and we ended the year with a net debt position of $506 million, so a strong balance sheet. For our shareholders, I'm also pleased to report a fully-franked dividend of $0.30 per share, taking the total to $0.63, a 3% increase on FY '21. Slide 5 covers our Coles investment proposition. It's been a while since we presented a slide like this. But given where we're at, coming out of COVID and also given the economic times ahead, it's worth reflecting on Coles, our investment proposition and how we plan to deliver long-term value to our shareholders. We operate in highly resilient long-term growth markets, and that's been not more evident than the last few years. We've clearly demonstrated our ability to maintain a leading market position despite all of the disruption and the disruptors with almost 60 quarters of consecutive supermarkets comp sales growth, excluding Q3 FY '21 when we were cycling the first wave of pantry stocking, which many of you recall that March was the higher sales period in supermarket history and also alongside [indiscernible] as many of us will remember. We are also a very important part of the Australian landscape with our established distinctive omnichannel network. This comprises almost 2,500 supermarkets, Liquor and Coles Express sites, our eCommerce platforms as well as our Flybuys loyalty program, which reaches more than 70% of Australian households and is available now in outlets covering approximately 20% of total Australian retail expenditure. Our trusted value credentials are strong and clearly important in the current economic environment. We delivered this through our exclusive to Coles range with just under 6,000 products and approximately 1,400 exclusive Liquor brands as well as thousands of specials every week. We're investing, particularly in automation and technology with 4 DCs landing in a 15-month period with Ocado and Witron, an ambitious but long-term program to grow shareholder value, sales and profitability. If we move to Slide 6, over the past few years, we've reported strong cash flow with an industry-leading dividend payout ratio at 80% or above. And you may recall when we demerged, there was some skepticism in some corners about whether we could maintain that. And I'm delighted to say that we have been able to maintain that for our shareholders. We have consistently delivered on our financial results and made significant investments in CapEx and a focus on returns. We take a disciplined approach to investing and our balance sheet is strong with solid investment-grade metrics, which provides us with flexibility to continue to look at new opportunities that will deliver long-term value for shareholders. It is also pleasing to note that Coles finished in the upper quartile of TSR for the ASX 100 over the last 3-year period. Moving on to our strategy, Slide 7. Since launching our winning in our second century strategy in 2019, we've made significant progress delivering our vision, purpose and strategic pillars. During the year, we evolved our strategy to set us up for the next horizon, which includes moving from having a sustainability strategy to having a longer-term sustainable strategy, which is an important difference. Our Coles Group purpose statement has been updated to sustainably help all Australians lead healthier, happier lives instead of feed. We've always sold more than just food, and this change reflects the wider role we play in our community and the ever-broadening range of offers, encompassing food, drink and home. The 3 strategic pillars have also been refreshed to include the following changes. We are extending our Inspire Customers offer from food and drink to also include home. Similarly, with this, we've expanded the anytime, anywhere shopping to include anyhow to meet the needs of our omnichannel customers. We're shifting the focus of Smarter Selling to innovation and broadening the technology-led stores and supply chain to technology and digitally empowered organization. In line with our sustainable strategy across all pillars, we are further embedding sustainability, for example, aspiring to be a destination for convenience, sustainability and health. If we move to Slide 8, we've also updated our strategic differentiators to reflect the progress we've already made and to encompass our wider ambitions in areas such as eCommerce, sustainability, team engagement and community partnerships. Our 5 strategic differentiators define our priorities, which you can see on the slide here. Firstly, to win in food and drink with a unique omnichannel offering, our priority is to deliver a unified customer experience through enhancements to our app and website as well as the increased investments in Ocado ahead of the FY '24 launch. In terms of our store network, as we've previously said, we will target longer-term net new space growth of 1.5% per annum. The second strategic differentiator is to be a great value exclusive brand powerhouse, and destination for health and convenience will be delivered through expanding our exclusive to Coles range to approximately 40% of sales as well as focusing on our Coles Kitchen and add free from food brands. We will achieve long-term structural cost advantage through Smarter Selling programs, including data, automation and technology partnerships. This will be delivered through an enhanced supply chain and operations through our transformation projects with Witron and Ocado. We will also accelerate self-service transformation store and focus on Smarter Selling food. This will include further initiatives around technology, AI and data. I have already spoken about our sustainability credentials and the 4 strategic differentiator is to be Australia's most sustainable supermarket group together with our partnerships and communities. There's a lot going on in this space. We have already secured transition to 100% renewable energy by FY '25, and we'll work towards 100% recyclable, reusable or compostable Coles Own Brand and Coles Liquor Own Brand packaging in Australia by 2025. From a customer perspective, we will continue to focus on their priorities including animal husbandry, plastics and our food waste programs, including our long-term partnerships with SecondBite and Foodbank. Finally, we cannot deliver any of our commitments without the right team. So our strategic differentiator of deliberate pace through our gauge team will see us invest in learning, development and the careers of our team members. We will expand our agile ways of working and on the safety front to keep our team members and customers safe. We are introducing a safety index beyond TRIFR, which has a greater focus on leading indicators such as people safety, food safety and injury management. Let's move on to some of the strategic highlights for the year, starting with Inspire Customers on Slide 9. During the year, we delivered trusted value with our exclusive brand ranges. We significantly improved eCommerce revenues, as I've mentioned, with Click & Collect rapid to more than 450 stores and same day home delivery to more than 520 stores. Liquor eCommerce sales grew by 49% through an expanded range, continued rollout of Click & Collect and our on-demand immediacy offer, which is now available in more than 400 stores. We provided additional value for Flybuys members throughout the year through our continuity programs, and we are very pleased with the addition of Bunnings and Officeworks to the Flybuys portfolio. Moving on to Slide 10, Smarter Selling. As I've said, our Smarter Selling program is a key strategic differentiator for Coles. Some of the initiatives implemented during the year include service transformation in store, such as trolley-assisted checkouts, or tacos as we call them, and customer packing benches. We've had front-of-store loss prevention initiatives continuing to roll out such as entry gates and glass [ illustrating. ] We've introduced dynamic markdowns to fresh produce and dairy categories after the success of deploying this in the meat category last year. And as you will have read, we aligned our meat operating models nationally. We streamlined distribution center operations through automatic truck entry and exit for the many supply of vehicles passing through our DCs. In eCommerce, we saw van optimization through adjusting store catchments, optimizing routes, shift times and customer offerings. We also delivered Energy savings through the installation of demand-based heating, ventilation and air conditioning as well as energy-efficient LED lights across the Coles Express network. During the year, we refreshed the Coles career website and recruitment processes using technology to deliver a more streamlined and efficient process. We renewed 50 supermarkets as part of our store format strategy, including 12 format As, 22 format Cs and 6 local stores. Whilst in Liquor, we had 191 Black & White Liquorland, 8 First Choice Liquor Market and 9 Vintage Cellar Evolution stores renewed. In terms of the progress on our transformation projects, the Ocado, Sydney and Melbourne customer fulfillment centers were handed over for robotic fit-out during the year. And internal fit-out of automation equipment and racking progressed in the Witron, Queensland automated distribution center and fit-out of automation commenced at the New South Wales site. Moving on to Slide 11, which is winning together. Across the many streams of work we have running in the business, I'm very pleased to report our sustainability achievements. Starting with safer choices together, we saw a 15% improvement in safety. Our safety objective is to focus on critical risk reduction, building team member leadership capability, the mental well-being of all team members and enhancing the food safety program. During the year, RUOK? Day and our GEM program, gratitude empathy and mindfulness, were delivered across all group sites and more than 1,000 team members completed mental health training to help them identify mental health situations and how to respond appropriately. We want to be known as a great place to work. This year, Coles was recognized as a gold tiered employer for the second year in a row at the 2022 Australian LGBTQ Inclusion Awards. Coles was also recognized by the Australian Network on Disability as a top employer for people with disabilities at the 2022 awards. Our ambition towards Together to Zero has seen a set ambitious targets across key sustainability areas, including climate change, waste and hunger. During the year, we secured a path to 100% renewable electricity through 3 additional renewable energy contracts to purchase large-scale generation certificates. I've mentioned where we are on the World Benchmarking Alliance. We also committed $10 million over 10 years to our Blue Carbon Partnership with the Great Barrier Reef Foundation. Finally, we seek to work together with all our stakeholders to bring about positive change under our Better Together pillar. During the year, we partnered with farmers in Victoria and New South Wales to produce Coles Finest Certified Carbon Neutral Beef Range. Providing customers with more sustainable options is very nice if you haven't had one. We achieved our highest net favorable score in the Advantage survey, the fourth consecutive year of improvement. Significant contributions were also made to charities and community organizations during the year, including more than $8.6 million donated -- raised and donated for FightMND to help fund effective treatments for Motor Neurone Disease. Moving to Slide 12. I would like to provide an update on our Ocado and Witron projects. As you know, this is a very ambitious program in retail, not just in Australia but worldwide. We're planning to land 4 of the largest automated projects in food within a 15-month time period of each other. By way of background, our commitment towards modernizing our supply chain led to our partnership in 2018 with Witron to develop 2 automated distribution centers in Redbank, Queensland and Kemps Creek, New South Wales. Our investment in this exclusive partnership with Witron, who are the automated DC market leader with over 70 facilities globally, is a foundation of our sustainable strategic differentiation by delivering long-term structural cost advantage through automation, data and technology. We have discussed some of these in the past, but the benefits of the automated DCs include safer work environments with improved service at a lower cost, reduced lead time to deliver better availability with both sites providing full case peak ambient range in each state and double the volume on half the footprint and approximately 2/3 of the operating costs of a standard site. The construction and installation of the automated DCs is progressing well despite all of the challenges, in particular, COVID-19 and disrupted global transport and supply chains. These factors, together with elevated commodity prices and higher labor costs have increased the estimated capital investment over the 4.5 year period inclusive of contingency to approximately $1.04 billion compared to the previously advised $950 million. The facilities are due to be commissioned within the previously communicated time frames, the Queensland facility in the third quarter of FY '23 and the New South Wales facility in the third quarter of FY '24. Moving on to Ocado. Our partnership with Ocado, the world's leading technology provider in automated single-pick fulfillment technology and home delivery solutions is a core foundation of our strategic differentiator to win in food and drink with a unique omnichannel offering. The Ocado program is focused on New South Wales and Victoria and includes a seamless digital customer experience with a unified app and websites, improved product availability and freshness with delivered in full on time, expected to be industry-leading. There's greater product range. The CFCs will open with an expanded range compared to our current average home delivery store and grow to approximately 40,000 SKUs over time, approximately double our existing home delivery store range. It will also give us increased network capacity with spokes to extend the CFC catchment areas for efficient last mile delivery. Our strategic plans have adapted to meet the significantly higher eCommerce sales that we have now than when we were back in 2019. We've significantly invested in the customer experience and capacity since the onset of COVID-19. We've updated our arrangements with Ocado as we've talked about last time around. Coles will manage the online store and web presence for the intake of orders, and Ocado will provide OSP automated facility fulfillment functionality through the CFCs and store pick channels as well as last mile solutions. At the time of the original announcement in March 2019, we expect the capital expenditure inclusive of upfront Ocado fees to be in the range of $130 million to $150 million over the full year development and construction period. In order to maximize the potential of the CFCs in addition to the significant eCommerce investments, we have enhanced the customer offer to include features such as on-site bakeries, fresh cut produce streams and expansion of catchment zones within the hub and spoke model. These investments, together with COVID-19 schedule delays, expanded scope and integration costs have increased -- the estimated total capital expenditure of the program to approximately $330 million, inclusive of contingencies and upfront fees. The automated CFCs are due to open within the previously communicated time frames -- the New South Wales facility is due to open in the first quarter of FY '24 and the Victorian facility in mid-FY '24. In FY '23, we expect to spend approximately $310 million in capital expenditure in relation to both Witron and Ocado, and this is included within the group capital expenditure guidance. The cumulative spend for both projects to the end of FY '23 is estimated to account for approximately 75% of the total project capital expenditure. If we move on to Slide 13, in terms of the EBIT impact, this is expected to be approximately $140 million in FY '23 and approximately $220 million in FY '24. As you can see on the slide, this is inclusive of ramp-up, dual running and transition costs, offset by other benefits. As we've said in the past, net EBIT benefits from Witron are expected to commence from FY '25 and those benefits from Ocado are expected from FY '24 as the customer fulfillment centers build volume. Moving on to the Coles strategy tracker, which we've been reporting every half for the last 3 years. I'm pleased to say that we remain on track for the majority of our metrics. I've talked to safety and team member engagement already. NPS and market share were impacted by flood and COVID-19-related availability issues. Pleasingly, availability is improving, and we also saw evidence of local shopping unwinding in the final quarter. Smarter Selling benefits remain on track. Cash realization was 104% and EBIT was in line with FY '21. Despite significant COVID costs, transformation project costs, flood events and lower Express earnings as a result of reduced mobility from COVID-19 restrictions. We will continue to report on our progress with the next scorecard update at our half year results in February. With that, I'll now hand over to Charlie, who will take you through the financial results in more detail.

Great. And thanks, Steven, and good morning, everyone. Now on Slide 16, which shows our Group results. Sales revenue for the year increased by 2% to $39.4 billion. EBIT was stable at $1.9 billion despite significant COVID-19 costs, flood events, lower Express earnings as well as approximately $30 million of transformation project costs in relation to the Witron and Ocado projects. Net profit after tax increased by 4.3% to $1.48 billion, and basic earnings per share by 4.6% to $0.789. As Steven mentioned, the final dividend for the year was $0.30 with total dividends for FY '22 of $0.63 per share, a 3.3% increase on FY '21. So moving to Slide 17. Supermarkets and Liquor reported sales revenue growth despite cycling elevated COVID-related sales in the prior period. In supermarkets, sales increased by 2.2% year-on-year and 12% on a 3-year basis, driven by a successful execution of trade plans, customer continuity programs, value campaigns focused on lowering the cost of living for customers as well as continued growth in eCommerce. eCommerce sales of $2.8 billion increased by 41% with penetration at 7.9% at the end of the year. This growth was driven by increased capacity through expansion of our home delivery and Click & Collect network. Supermarkets EBIT increased by 0.8% to $1.7 billion with higher sales and Smarter Selling benefits partially offset by COVID-19 costs, transformation project costs in relation to the Witron and Ocado projects. In Liquor, revenue grew by 2.5% and 18% on a 3-year basis and was driven by strong trade across the year and growth in the eCommerce sales. The closure of on-premise venues during the first half of the year during the lockdowns in New South Wales, Victoria and the ACT also contributed to revenue growth. Liquor EBIT of $163 million, a slight decline of 1.2% driven by increased depreciation and amortization as a result of investments in renewals and new stores. Express revenue declined by 5%, but increased by 8.1% on a 3-year basis. Express revenue was negatively impacted by lower food court traffic due to lockdowns in the first half as well as cycling strong tobacco sales in the prior corresponding period. Express EBIT $42 million declined by 37% due to lower fuel volumes and commissions driven by reduced liability as a result of COVID-19 restrictions in New South Wales, Victoria and the ACT during the Delta COVID-19 wave. The other segment, comprising corporate costs, property earnings and Coles 50% of the Flybuys joint venture recorded debt cost of 51% for the year. So now turning to Page 18. Operating cash flow, excluding interest and tax was $3.6 billion, with cash realization of 104%. This was supported by an improvement in working capital versus the prior corresponding period with higher trade payables given the timing of year-end 26 June, partly balanced by an increase in inventories held at year-end to support availability. This was partially offset by a reduction in cash flow from provisions as a result of the utilization of Witron transformation project provision and a reduction in employee entitlements. Trade payable days remained steady, while inventory days improved relative to the prior corresponding period as a result of sales growth or fluctuations in inventory balances throughout the year as availability was challenged at certain times. I'll now take you through CapEx on Slide 19. Gross operating capital expenditure on an accrued basis was $1.2 billion, driven by new store openings and renewals, accelerated eCommerce growth, in-store service transformation and the Ocado and Witron transformation projects. Within Supermarkets, CapEx was incurred in relation to 11 new stores and 50 renewables and in-store investments such as trolley-assisted checkouts and fresh produce easy ordering. Liquor CapEx focused on 16 new store openings and 208 renewals, in particular, the new Black & White Liquorland format of which 191 were completed during the year as well as investments in IT systems. Finally, continuing to optimize our property portfolio, we reported a net property inflow of $12 million compared to the outflow of $35 million in the prior corresponding period. Now turning to Slide 20 in relation to the balance sheet. As of 26th of June, we reported negative working capital of $1.4 billion, capital employed of $11.4 billion and net assets of $3.1 billion. We have maintained a strong balance sheet with investment-grade metrics, which will provide flexibility for future growth. Starting with working capital of negative $1.4 billion, working capital improved by $232 million compared to the prior corresponding period. Total net assets improved by 3.1 million, most notably for investments in property, plant and equipment and equity investments, which increased by $343 million compared to the prior corresponding period, largely driven by an increase in PPE consistent with the capital investment made in technology, partially offset by amortization. Net debt, excluding lease liabilities of $506 million, was $151 million higher compared to the prior corresponding period. Turning to capital management on Slide 21. As we announced in the first half year results, Coles established a $1.3 billion 4-year Sustainability Linked Loans under its bilateral debt facilities, replacing existing debt commitments. The arrangements draw a direct line between Coles' sustainability performance and cost of capital, provide transparency and accountability as we work to fulfill our ambition to be Australia's most sustainable supermarket. On credit ratings, we remain committed to solid investment grade ratings with S&P and Moody's, which provide us with the future flexibility to invest in growth. Coles maintains its existing annual dividend payout ratio target of 80% to 90% franked to the maximum extent possible. Turning to the current market environment, Slide 32. Before handing over to Steven, I'd like to make some comments on the current environment and some of the headwinds we are facing. Firstly, as you are all aware, we are seeing rising food inflation from an increasing number of supply and price increase requests and weather-driven availability issues in fresh produce. High prices and other cost of living pressures are starting to impact customer behaviors where we are seeing them make more value-oriented choices. For our suppliers, we do have an effective and well-established process to manage the volume of supplier requests, which we are seeing and consider the merits of such requests, being both mindful of both customer impacts and our grocery code obligations. For our customers, we'll continue to invest in trusted value through our extensive exclusive to Coles range, value campaigns and lowering the prices for longer in Liquor. Overall, we expect broadly a neutral impact to our earnings from supply cost inflation. Regarding rising cost of doing business, our successful Smarter Selling program has been designed to help mitigate cost pressures. We're also developing Smarter Selling 2.0, which we have more to say about this in the not-too-distant future. We have minimal exposure to rising electricity costs and interest rates in the near term due to our renewable energy agreements and hedging strategies and our debt structure. We'd like for many returning back to business as usual. Overall, we expect the unwinding of COVID-19 costs to be a benefit to earnings in FY '23, while we'll be cycling the elevated sales in FY '22 as always. We'll continue to have a strong focus on managing the COVID-19 costs. Currently, these costs are mainly related to absenteeism due to COVID and the flu and lower than our Q4 run rate. We will use our Flybuys data and analytics to realign customers to turn to local shopping during COVID while flexible rostering and team mix optimization will help to alleviate value challenges we experience around absenteeism in FY '22. Finally, regarding the battle for talent, we're continuing to invest to attract technology and digital talent while our refreshed career website and recruitment processes will deliver more efficient recruitment at all levels of the business. We also have an award-winning graduate development program. I hope you take from the slide the broader presentation and the message that while we are not immune to the challenges facing the broader market, we are actively responding to these challenges and seeking to ensure we take a long-term view in relation to delivering value for our customers and partnering with our suppliers to ensure sustainability of their businesses. Importantly, we are well placed with the investments we are making in new technology, automation and data to deliver long-term value for our shareholders. Now I'll hand back to Steven, who will take -- make some concluding remarks on the outlook before we go into Q&A.

Charlie. So I'm on Slide 34 here. As Charlie alluded to in terms of forecasting for the year, obviously need to remember that we'll be cycling COVID-19, and we are already cycling some of those in the first half of FY '22 in New South Wales, ACT and Vic; and then obviously, we'll be cycling inflationary sales in the second half of the year. In July, we have seen further cost price inflation in produce due to flooding, in bakery due to weak commodity prices, and in packaged groceries due to various supply chain cost increases, including wages, packaging, food ingredients, freight. In Liquor, sales growth is also expected to be impacted by the cycling of COVID-19 lockdowns in the first half of FY '22 when some pubs and clubs and restaurants were closed. In Express, weekly volumes and sales are expected to benefit from increased mobility, having been impacted by lockdown restrictions. The scale of this benefit will very much depend on fuel prices and the impact of the government's reinstatement of the full fuel excise levy of $0.22 at the end of September. In other costs around corporate, they're expected to be around $95 million this year, and property earnings are expected to be slightly below FY '22 levels. With increasing inflation and rising interest rates, placing pressure on many households, Coles will continue to focus on delivering trusted value to customers through our differentiated ranges and our Flybuys loyalty program. As you will have seen this week, we have locked the price of more than 1,100 products across supermarkets and online until at least the 31st of January 2023. And have begun lowering the prices on an additional 500 products across the store. Consistent with our suppliers and customers, we are also seeing inflationary pressures impacting our own cost base with increasing wages, rent, fuel, supply chain and capital costs. In addition, COVID-19 and the flu has seen an increased team member absenteeism costs continue in the business. I won't mention the Smarter Selling programs. We've probably touched on that enough, but we are turning our mind to Smarter Selling 2.0. And obviously, we won't be complacent about delivering the $1 billion this year. In terms of store development programs, we're expecting to open around 20 new stores, close approximately 9 and renew approximately 40 in Supermarkets. In Liquor, we are accelerating our new space program, and we expect the renewal program to be at a similar level to FY '22. F '23 will be end of the year of significant investment for Coles as we continue to commit resources and capital to transformational projects, which will underpin our customer experience, efficiencies and long-term shareholder value. Capital expenditure is expected to be around $1.2 billion -- or between $1.2 billion and $1.4 billion, inclusive of the Witron and Ocado projects we've talked about. Finally, for those of you who like the complete burger or sees a solid, I'm delighted to announce the return in abundance as Curtis [indiscernible] would say, of the iceberg lettuce to Coles at around $3. Alternatively, if that's not your thing, then you're looking for a Father's Day solution or treat, then please don't forget Coles or Liquorland in the coming weeks. Thanks for listening. And I'll now hand back to the operator for Q&A. Thank you.

[Operator Instructions] Your first question comes from David Errington from Bank of America.

Steve, I'm trying to -- if I go to Slide 32, I think that this is the key chart that most people are trying to grapple with or certainly I'm trying to grapple with and what the message you're trying to tell us. And then when you look at, I suppose, what you didn't include in Slide 32 was the impact of the costs in Slide 13. Now -- and that's with bringing Witron and Ocado. It's quite a significant level of OpEx. When I look at that slide, it shows me that you've got 2 really tough years ahead of you in '23 and '24 in terms of operating costs, and it shows if the message -- correct me if I'm not getting this message because I suppose what I'm trying -- the question that I'm asking is what are you trying to tell us by giving that. Are you trying to tell us that the earnings are going to be pretty tough in '23 and '24? What's the message you're trying to give us? Because when I see that, there's one green arrow up, but that's only COVID. That's a one-off. But there's 2 big red arrows down that rising cost of doing business, structural change in workforce and then I suppose, added to that, the Witron and Ocado, it looks to me that the next 2 to 3 years are really going to be tough for you guys. Now you guys are doing a great job managing your business. I mean, when you look at your gross margin, your cost of doing business, you're really running it well. You're operating a business that's benefiting shareholders and employees and customers to the best of your ability. The industry looks like it's going to be pretty challenging in the next 2 years. Is that the message you're trying [indiscernible] in Slide 32.

Look, I might start. Thanks for that, David. I'll make a note to that and let the rest of the team know. Praise indeed, thank you. The -- I think what we're trying to do here is just articulate a few things that have been, I guess, circulating around and about, but just clarifying what they mean for Coles. And I think there's been a -- some sentiment in the marketplace that inflation -- that inflation will be a good thing for all businesses. And what we're trying to say is that if you look at the price increases that have gone through so far, as always, with price increases, there is a lag effect on our P&L. And as we've talked about previously, we can either put the price increase through the full gross margin percentage. We can pass on the absolute price increase in dollars or we can maintain the pricing. But people shouldn't assume the gross percentage is going to -- the gross margin percentage is going to remain stable or increase as a result of those things. The reason why our gross margin has been improving for a number of years now is due to strategic programs around Smarter Selling and strategic sourcing and so on. So that's one message that we definitely wanted to give everyone, which is don't naturally think that higher inflation is going to give you a significantly better sales line, which all flows through to the bottom line because there are a lot of costs coming through our business at the moment, as you'll have seen from work and the increases there that impact most of our team members. So that's point number one, which is trying to provide clarity around the impact of inflation. The -- I think the costs of doing business are probably a little bit better. And third, I think we're in good shape relative to some others in the industry because we have done some hedging, as Charlie referred to earlier, but we're not immune to the costs that are going on and obviously Smarter Selling helps us. COVID is -- although there's only one line going up and two going down, the COVID unwind costs are significant. That was a huge number in our P&L this year. So not all of these lines are equal. So I wouldn't be sort of saying there's four lines, one is flat, two down and one's flat, therefore, net-net, it's all negative. I think you have to work out what each box means. And then the structural change in the workforce, everybody in Australia that I speak to is experiencing high levels of turnover. They're experiencing longer times to fill roles. There are some sectors that are very challenged like technology and so on. And what that will mean short term is that the price of technology-type projects will go up or some projects will be delayed. But I'm not sure again that everybody is factoring in what impact that will have on different types of businesses. So really, what we're doing here is talking about the 4 buckets that there's been a lot of commentary on and sort of trying to clarify what it means for us. But there's -- by no means are they all equal. Charlie?

Yes. Thanks, David. If I can just add, obviously, what Steven has outlined is, clearly, there's a lot of moving parts here. But if I can then, David, take you just a little bit about the Ocado and Witron projects, clearly, what we're trying to do is give you a bit more visibility around those project costs and on EBIT. But let me just take you through those because I think it's sort of important because a part of those costs is actually a rephasing. So if you look at FY '22, we had guided that those costs would be about $75 million or up to $75 million and for '23, guiding that they would have been up to about $160 million. So when you look at over a 2-year period, it's $235 million. What we're really sort of saying now, it's $280 million inclusive of what we spent actually in FY '22. So what we're really talking about in terms of those project implementation costs, it's over a 3-year program. It's about $280 million inclusive of what we spent in FY '22. But also, we're just giving you some visibility around depreciation, okay? So it wouldn't be a surprise. You've got $1 billion of the Witron project landing effectively in FY '24. If you just take -- these are long-term facilities with depreciation. It's not that hard to sort of calculate that, that would be a significant depreciation experience in addition to what the Ocado facility. So that's really what we're trying to give you a guide in Slide 13.

It's not all doom and gloom then. It's -- actually, there's some offsetting. It just look -- it was a bit doomy, that Slide 32, and that's it. You've made me feel a little bit better.

The next question comes from Ross Curran from Macquarie.

Steve, I thought your explanation around the increased CapEx around the automation projects to the COVID expanded capabilities appeared logical. But I'd just take you to the Rem Report where the Board has said you haven't achieved their expectations on the Ocado program. Can you just help us understand where their thinking is at versus where you're on. Is that maybe where the discrepancy sits?

Yes. Thank you, and thanks for getting into the Rem Report, as what we've been busy this morning. But just a couple of things on that one is on Ocado, there were 5 or 6 metrics in the year that needed to be achieved. And I think we, in year achieved most of them collectively. Where the Board and I were, was really around the longer-term program, which is if we're announcing that we're going to be investing more in the program, then it's inconsistent with paying an STI payment. So that was what happened in that regard. But the actual progress in the year was getting more around investing more in the program over time than originally planned.

Sorry. But I'm just struggling with that because assuming you're investing more because you can see more opportunity in it. I don't understand why you're getting penalized if the opportunity's that's actually bigger than you first thought.

Yes. Look, that's not one for me. Now look, at the end of the day, we have to deliver what we wanted to do in the year. And we also look to deliver what we wanted to do in the program more broadly. And I think it's quite right that if you change the program and the investment goes up, then obviously, the Board should look hard at how that impacts everybody. So I am in agreement with it, by the way. I didn't have a different view on this one. So look, I'm not going to lose any sleep over it. I think it's the right decision. And I think it's the right decision that we invest more in Ocado to maximize the potential of the CFCs, given what we know about the market today.

And as we know, Ross, yes, the investments -- and there are a number of elements to that investment. Clearly, the enhanced experience that we're looking at offering our consumer through the Ocado program. Clearly, the additional scope that Steven spoke to with the on-site bakeries and fresh-cut produce rooms and the like, the expanded sort of catchment area. So there are sort of different moving parts there in relation to where we are investing additional dollars in that capital program.

Your next question comes from Adrian Lemme, Citi.

Just wanted to focus on the store portfolio, if I could. So there were 50 store renewals in supermarkets this year out of 835 and then 40 in FY '23 is the guidance. So that's less than one in 20 supermarkets being refurbed. Can you talk about what we should expect? What's normal for refurb activity? And also just the quality of the store portfolio relative to your major competitor at the moment, is there a major investment required to bring some of the older stores up, for example, the old Bi-Lo stores that were converted to Coles.

Yes. Thanks for that question. It's a very good one. The way we view store renewals is as follows, which is we've tried to segment the store base as you're probably aware, into Format A, B and C. And then we've got a growing number of Coles locals as well. What we're not trying to do is to invest money in stores that we don't think are long-term contributors to Coles. And so one of the differences with Coles to other operators is that we are closing more stores. And it's not because they're necessarily an anchor. There might be an anchor in 5 or 10 years. But equally, if they're not making a contribution, we're not going to keep them open for market share purposes or any other purpose. So we have a more active store closure program than I think anybody else in the marketplace. So that takes -- and you've seen that this year, we almost had sort of net no new stores out there in the marketplace. So we will continue the store closure program of unproductive stores, which means that we're not investing capital in them either. For stores where we think they are viable, that's where format C comes in. And what we try to do there is focus more on value, but we also try and take out some costs in those stores. And that's been through the self-serve Deli and a few other initiatives. If we look at the rest, the key priority for us is to continue investing faster in the format A stores that tend to be our bigger traders. And for those of you who round about, Bondi would be an example of one of those that we've completed recently. What we've also got is a program that's not called renewal but touches an awful lot of stores every year, which is more around category innovation, and that's things like treat bars, MOSHI, all those type of things, flat breads and so on. So the store numbers that you've seen over the last few years, that's the sort of range of full renewals that will get done, so to speak. But I don't think that's all that's happening. There is a significant category improvement program going on behind the scenes, and there is a fairly significant store closure program going on behind the scenes that we end up with a store base which continues to grow at net 1.5% over the long term but becomes a lot more productive, and it's a lot more resilient to the changes that we're seeing in the home shopping space.

And just to put a few more numbers to what Steven has sort of indicated, I think as we've sort of guided for FY '23. So we're talking about approximately 20 new stores in super this year, closure of approximately 9 in terms of what the plan looks like, but renewing about 40 stores during the course of the year. So -- and that's obviously consistent with sort of levels that we've done previously.

The next question comes from Bryan Raymond from JPMorgan.

Just on the like-for-like outlook and impact that we're seeing at the moment from a bit of trading down going on as inflation picks up in certain categories, I'm just a bit interested in how you're seeing the outlook given 4Q inflation was ahead of like-for-like. And given cycling lockdowns, 1Q '23, that gap should widen. How much trading down are you seeing, particularly in those categories that have gone through 2 or more price rises? Has that stepped up much in the last sort of 6 to 8 weeks as that's something -- that's the feedback that I seem to be getting a bit more recently. Just interested if that's something you have experienced.

Yes, probably just a few things to add, and I'll let Leah do a bit of a deeper dive for you. But what we've seen -- well, what we saw in Q4 was that our market share continued to improve as local shopping and availability improved during that quarter. What we've seen in the current quarter is that for the first time, we're seeing some significant increases in transactions, but we're also seeing some reductions in baskets as well. So it already feels like we're heading towards a bit more of a normal. In terms of shopping patterns, the days are almost back to where they were with both Saturday and Sunday very much back to normal from a weekend point of view. As far as time of day versus pre-COVID, there's more shopping going on in the mornings and less shopping going on late at night. I'm not sure whether that was the impact of curfews and everything because it has changed people's views on going out after dark, particularly maybe in winter and things. So that's changed. But first is where we were pre-COVID, we still got bigger baskets and less transactions, but it is interesting that the transactions are in quite healthy growth at the moment, and we are seeing increasing customer numbers through our Flybuys program. As far as trends and trading down is concerned, I might hand over to Leah. Leah?

Thanks, Steven. So in the very back end of the second half, we did start to see some trends that would indicate that the beginning of trading down is starting to happen. As we sort of talked about at the Q3 results, it is -- has been quite slow to come on. And I think that has been a result of a quite good household savings. But there's definitely a cohort of customers that are starting to exhibit those behaviors now. And what we've started to see is that we're seeing stronger growth versus the rest of the store and what I'd call your sort of core value food category. So that's things like pasta, canned meals, canned veg and the like. And then within those categories, what we are seeing is that we've got a much higher growth in your Own Brand line than what we're seeing in the proprietary line. So you're seeing that shift into the cheaper items to actually make a meal. And then within those categories, the cheaper option that's available. We've also seen the trends start to happen in meat as well. That's probably been a more long-standing trend, and I think it probably is a good indicator of what we can start to see more ongoing as the inflationary environment continues. And so there where we've had beef that's been inflation now for a couple of years, we have seen a fairly consistent trend out of the red meat categories and into the cheaper proteins like chicken. And the other thing I probably would say is that it's only a cohort of customers. So at the sort of upper end of the affluence spectrum for our customers, actually, spending there is holding up very strongly. And I think we are seeing that also reflected in the data that we're seeing from some of the consumer spend reports that are coming out in the ABS around how buoyant hospitality continues to be. So for many consumers, eating out and taking advantage of that in a post-COVID world, that is something that we're seeing very strong growth in and they are likely the customers in our stores where we're continuing to see spend hold up quite well and no trading down happening. So what I'd probably say is we're almost seeing a bifurcation where for customers where budget is important, it's starting to happen. But for customers that have secure jobs and good income, they're still continuing to enjoy eating out, buying premium foods in the store and have less regard for what they're spending on the grocery bill regardless of the inflation that's coming through.

Yes. And the other thing I'd add to that -- thanks, Leah. The only thing I'd add to that, Bryan, is from a volume point of view rather than a trading point of view is probably produce has been the area that we've been impacted. A good deal of that has been related to floods. We've also seen a little bit move into canned and frozen sort of veg and things, but we expect those volumes to sort of come back now that the $3 lettuce is back in town with a few friends shortly as well.

I was up in Queensland in the last week, Brian, and I've got to go and see a whole heap of the iceberg lettuce farms. And I've got to tell you, there is a lot of iceberg lettuce on its way. It is magnificent and it's beautiful quality. So I hope you get a chance to get in and get a $2.50 lettuce in one of our stores in Sydney this week.

The next question is from Tom Kierath from Barrenjoey.

Just got a question on the food cost growth in the second half. On my math, it grew at about 8.7% ex D&A. I think if you stripped out the Witron and the COVID cost, it's about 7%. Just a couple of things on that, I suppose. Are there any one-off factors driving that growth? And can you maybe give us a few building blocks and then just how to think about it into '23? Obviously, wage rates are going up into '23. And I just want to think about kind of underlying when you strip out the Witron and COVID stuff, which you know how that will be. But just how you're thinking about that?

Yes. So in terms of the book, the cost of the -- cost of doing business, [ if you look at ] some of the biggest impacts on that in '22. I mean store Rem was obviously driven by the increased sales volumes through the year. Clearly, we had COVID costs, which were elevated in the cost of doing business. And then as I called out earlier, we spent $30 million on Witron and Ocado. But just reminding you that clearly, we continue to make investments in digital and IT and eCom sort of initiatives. So if you stripped off some of those things, but also when we look at -- yes, there was also clearly benefits from the Smarter Selling program, about 2/3 is Smarter Selling, actually impacts the cost of doing business line, and we did have some favorable movements in provisions. But if you look at it on an underlying basis, and I think that's probably the way to sort of look at it and you strip out some of these sort of one-offs and the like, then we probably saw about a 2.6% increase year-on-year in the cost of doing business. Yes. And clearly, yes, including wages -- sorry, that was over the year, over the 4 months.

Yes. It just looks like it really stepped up in the second half, which is kind of what I'm trying to understand because that's kind of the rate, I guess, at which you're entering the FY '23 year.

Yes. Well, I think let's go through again some of the -- just some of those trends that really wasn't anything that was really specifically second half related. I think all those elements where I talked about the increased volume was quite significant for the year. So the second half, the underlying rate is about 3.3%.

The next question is from Shaun Cousins from UBS.

Just regarding cost savings, maybe to address some of those sort of issues there. Can you talk a bit about Smarter Selling 2.0 and the Witron savings just in that your EBIT this decade has very much been supported by Smarter Selling. You've called it run out to the end of '23. Should we envisage 2.0 as something that could hopefully maintain that run rate of cost savings? And is it a 1-year sort of gap to get you to Witron in fiscal '25? Or could it actually be something that, that continues on, just given how important cost savings have been for the business and the cost pressures that you're facing, please?

Yes, Shaun. Thanks. Perhaps I'll take that first and if Steve wants to elaborate further on it again. Clearly, what we're calling out is Smarter Selling 1.0 has been an amazing benefit to the business over the last 3 years. And that continues, obviously, into FY '23, where we're very confident that we'll deliver on our commitment of $1 billion cumulative savings through FY '23. But in terms of sort of going forward, I mean, Smart Selling 2.0, it really just means that -- it's just the way we're going to do business going forward. It's always going to be on -- Smarter Selling 2.0 is just part of our normal operating rhythm here of actually continuing to focus on the cost of doing business, focused on actually increased automation, where we can use technology, where we can actually continue to keep a lid on from cost. So we're working through what Smarter Selling could look like. And if that helps work us through until net benefits, obviously, that we expect from Witron in FY '25, that's just part of what we expect as our normal modus operandi.

So to be clear that you don't expect to have a gap where you hit an air pocket and you run out of cost savings. Is that essentially like in '24? That's what I'm very much interested in, please.

Well, Shaun, I'm not going to give a forecast in terms of GAAP and an earnings forecast going out that long. I think what I'm sort of indicating is Smarter Selling will be the way we continue to do business going forward. And if that works for filling gaps as you describe it or continuing to underlying earnings, that's what our focus continues to be.

We'll probably be able to say more either at the half year or full year, Shaun, in terms of what that next program looks like.

The next question is from Craig Woolford from MST Marquee.

Just a question just around the gross margin. Maybe I'll just start off with the question around the Smarter Selling benefits that were in the gross margin for supermarkets, and I'll follow up with a clarification. You want to provide that?

Yes. Great. Okay. Well, that's sort of indicated earlier. I think about 35% of our Smarter Selling benefits sort of work their way through into gross margin. And there's really 3 main buckets, if you will, 3 main areas. One's around the sort of stock loss type measures that Steven sort of indicated earlier, the glass [ illustrates ], the sort of gates that we sort of put into our stores and the like. Another element of it clearly is the fresh produce easy ordering, which has obviously helped in our waste and markdowns space and then so the logistics side of the business where we've actually increased some automation into the DCs around the truck entry and exits but also in things like the eCom van optimization, how we actually route our vans, how we actually, if you like, route that you order to the various store catchments, but also in terms of shift time, et cetera. So there are some of the sort of key initiatives that have helped drive some of the gross profit improvement through Smarter Selling.

Okay. That makes that clear. So the gross margin gains actually accelerated in the second half on the first. And taking what you've just said there around Smarter Selling, it does still look like there was an acceleration in underlying percentage gross margin improvement in the second half compared with the first half. Just interested in what were the drivers of that better gross margin performance in the second half of '22.

Yes. Look, clearly, there's probably a couple of things. I think there was certainly -- Smarter Selling sort of phased a little bit stronger than the second half compared to the first half. So in terms of the impact on gross profit -- or gross margin, but also some of our shelf margin sort of initiatives, including our strategic sourcing where we work with our supply partners in terms of optimizing their costs in terms of product and how that product gets to the shelf. And clearly, we had some also with higher pricing for our export beef and export meat as well sort of all contributed towards effectively shelf margin. We did see some sort of mix benefit from beef sales, again, through a lot of our strategic partnerships with our suppliers.

Yes. The one other thing I would probably add to that in terms of the shelf margin benefits that we had come through. One is we did see some really good benefits coming through from range reviews in the second half. So we have had quite a strong focus in terms of improving the mix through range reviews and ensuring that the innovation that we're bringing through is category accretive from a margin perspective, and that's been quite successful. The other thing I'd call out is that because of the lockdown that happened in H1 in New South Wales and Victoria, we saw very strong meat sales in that first half and meat in general, has a lower shelf margin than our packaged areas. You then saw that reverse out in H2 where we saw more normalization as the in-home consumption elevation came off, and we came back to normal behaviors. And then you brought your [indiscernible], a reversal of that, and you saw over-index in the amount of package going through, which tends to run at a higher margin. So that definitely has impacted it as well.

Okay. Leah, just a follow-up because back in the third quarter, there was a comment that promotions were lower in that March quarter, mainly because of Omicron making it very difficult. What was promotional intensity like over the half compared with the prior corresponding second half?

You're absolutely right. Q3 did have reduced promotions because of the Omicron impact. I mean it's actually -- seems like a very long time ago now, Omicron. But we had some real struggles across many of our suppliers around labor at that time because we just had so many people that were out with COVID. And that did impact our availability, and we pulled back on promo during that time. As we then sort of came out of that and have gone into Q4, that is really all normalized now when we're back to what I'd probably describe as normal and very healthy promotional penetration levels.

The next question is from Ben Gilbert from Jarden.

Just on the trading update, I suppose sort of lack thereof, from explicit numbers, could you just give us some color on how you feel the consumer is going to behave through this year? And I suppose what I'm trying to sort of understand is that, ultimately, I wouldn't think that volumes are going to go backwards in grocery. And you obviously exited the quarter around sort of 4.5% type inflation. Is that sort of what we should think about as the baseline, you would think, in terms of flat volumes and then the benefit of price. So that's the first part. And then the second part, is that a decision not to give an explicit number for trading update, which you've given in the last year results?

Yes. It's a good question. I'm not sure I actually have the answer. I'll give you some thoughts. One is, clearly, hospitality spending is probably higher than anyone expected. I can't remember the exact numbers, but I thought hospitality might have risen to about 29% of total food sales now on the last ABS numbers, which is a couple of percentage points higher than it was pre-COVID despite the fact that there aren't enough chefs or waiters or waitresses in the industry. So there's a lot of consumption going on in a more condensed time period, which is a little bit what we're seeing in supermarkets as well. So anyway, if you think about you can only consume food at home, at work or in hospitality, then there's no doubt that the food market overall is in good health at the moment. But also bear in mind that every meal or coffee consumed in a hospitality venue is one not purchased in a supermarket. As far as volumes are concerned, in the supermarkets, we've called out produce as being the biggest issue that we've had over probably the last 4 or 5 months in terms of not having everything available, and that obviously extended beyond iceberg lettuces. We're starting to see that come back a little bit now. And then you've got the cycling of COVID last year where there was more in-home consumption as well. And then what we've seen overseas is a genuine volume reduction in some places as well as people actually consume less. And over there, we've seen far more dramatic shifts than we've seen here so far of people avoiding meat or just trying to make as many meals as they can out of a bag of rice or whatever it is. So I think we can expect some volume contraction in the market, which might come back slightly as maybe hospitality gets impacted further on the track once savings have come down a bit. But at the moment, there's still so much savings around that both markets are growing in dollar terms. How long that will last, we don't know. But there's clearly maybe up to 20% of consumers who are obviously finding it tough and there's still a lot of fixed interest rate mortgages in society, and a lot of those will roll off at around about -- well, later in the year, but around about Christmas time. And so there'll be a delayed impact on some of the interest rate rises that were -- we're seeing out there as well. So it's a difficult one to call, but I think volume will be challenging overall for the industries.

But ultimately, Steve, it sounds like you're pretty happy with your market share trends based on what you're saying. You said they improved or steady through the second half. Is that right?