Coles Group Limited (COL) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Coles Group Limited Q1 sales 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 first quarter results from a very damp Melbourne. I'd like to remind everybody that this is a sales call and not a profit update, which will obviously happen -- hopefully, like normal in February to cover the half year. We also recognize though, that there are continue to be a number of moving parts. So anything we can do to help, we will. Joining me on the call this morning is Charlie Elias, our Chief Financial Officer, who many of you know and a number of our executive leadership team chiefs. We've got Matt Swindells from Operations and Sustainability; Ben Hassing from E-commerce; and Darren Blackhurst from Liquor. Unfortunately, Leah Weckert from Commercial and Express can't be with us today. She's feeling unwell and we hope she gets better soon. So you'll have to put up with me on any merch type questions. Before I start, I wish to acknowledge the traditional custodians of this land on which we meet today, the Wurundjeri peoples of the Kulin nation. We acknowledge their strength and resilience and pay our respects to their elders, both past, present and emerging. Just a quick focus on the results and then a bit on outlook and we'll open up. But we were pleased with the quarter results and the trajectory within the quarter. Group sales hit $9.9 billion and comp sales grew 1.8%, despite cycling the COVID-19 lockdowns that many of us will remember, little bit of scar tissue in New South Wales, Victoria and the ACT. We also note that perhaps surprisingly, the hospitality sector just continues, certainly on the data that's available to go from strength to strength, and I think hit 30% of total food expenditure, which is up from about 26% or 27% pre-COVID. So still a lot of eating out going on in the marketplace, although happy to update on some further research we've done recently. On a 3-year basis, pre-COVID, if we'd gone back to those times and sort of said what about the next 3 years, if we said 14% in supermarkets, 15 in Liquor and 7.5% in Express, I think we'd have taken it quite quickly, and been pleased that, that has remained stable, despite everything that's gone on. In Supermarkets, as I've alluded to, we saw a strengthening of sales trajectory in the quarter and beyond, driven by approved availability, particularly in produce. Obviously, that's on watch, given what's happening with rain on the East Coast, but we did see significant improvements in produce availability, and in many cases, some better pricing. We've had our -- new value campaigns have dropped and locked, and we're seeing the unwind of local shopping, as consumer behaviors normalized and happy to talk about that further as well. Our e-commerce business continues to grow penetration, with supermarkets up to 7.6% from 7.4% in the prior quarter, and a 3-year growth of 105%. And on the Liquor side, up to 6% from 5.5% in the prior quarter, a 3-year growth of 348%. We remain committed to delivering trusted value. As we talked about last time at the full year results, we think about all stakeholders when we make decisions. Obviously, shareholders are front of mind, but so are our customers, suppliers, our team and the communities that we serve, and we know that there are many customers out there today doing it tough equally. We know that there are many customers out there, who are looking for innovation around sustainability, health and convenience, and it is about getting the mix right. But it's pleased -- I'm pleased to say, we've had a positive response to what we've been doing. And albeit that inflation continues to increase to around 7%, that's still well below the national average of 9%, and we'll continue to try and keep prices down, as best we can. With regards to sales outlook, as I've mentioned in the first 4 weeks of P4, we've seen continuing strengthening of sales volumes and transactions. And as I've said, we're seeing some good traction on the 1,000 prices locked and 500 prices that we've been dropping through the quarter, which is very much aimed at the center of the shopping basket, not the peripherals. Cost price inflation is expected to increase, given the ongoing level of supply increases that we're seeing, as well as whatever impact we might see from the flooding events and particularly around farm produce type products. We're not immune to inflationary pressures in our own business, and we're seeing that in logistics, fuel costs, salary and wages and construction costs on projects as well. So certainly something to bear in mind. We continue to make increased investments in technology and digital and data, both in Coles and at flybuys, and as a result of that, plus the right-of-use lease assets, we expect depreciation to be $1.7 billion or around $1.7 billion for the full year. I'd like to acknowledge the work of our team, our suppliers, our community partners. This is the new normal, I think, well, post COVID -- hopefully, post-COVID, but we are entering perhaps a bit of a changing time now, where we just have to accept that there's always going to be some sort of disruption out there. And the great news is, we've built some muscle during the last few years, and I think we're far more resilient and an agile organization now than we were 3 years ago. We've got teams helping on the ground in Northern Victoria and everywhere else, where there is floods. And again, our thoughts are with those communities and indeed with our team members who've lost or had their homes damaged. So despite all of those things that are going on, we're pretty optimistic about Christmas. We've got our best range ever, particularly around easy entertaining and gifting, and as you'll have seen in the more detailed commentary, we've launched meal kits, which we think is an opportunity for the future, if we quite like it, curry or a steak show great value, then I'm sure you like -- quite like one of ours. So with that, I am going to hand over to Q&A. Thank you.

[Operator Instructions] Your first question comes from Shaun Cousins with UBS.

Just in terms of your outlook, you've mentioned quite a lot about costs, Steven. I'm conscious of the sales release, but you've decided to mention more about costs. Is this reiteration of the cost comments that you highlighted in August and then now sort of indicating that D&A is going to be above market. Does that indicate that you don't believe you can expand EBIT margins this period, or are you confident that your higher dollar gross profits can actually see that come through? I just responding to what you've put in your release, particularly around costs?

Okay. I'm going to hand over to Charlie in a second, but I'll just start with saying that, you should know me better by now. Until now, you're going to get an EBIT forecast out of me in a sales call. It's pretty difficult in a profit call, never mind the sales call. So I don't think we'll be going down the -- what's the EBIT margin for the year or whatever. I think Charlie is quite keen to talk to Slide 32 though, and just update everybody on what's happening there. Charlie?

And Shaun, I'll more than gladly give you an EBIT number in February. In terms of -- look, in terms of costs, we're not calling out anything more than what we called out at the full year results in August. And in fact -- subsequently a few things, it's pretty much playing out as we would have expected, but there are some things that it's worth highlighting. Firstly, on the -- yes, in terms of the gross profit line effectively, we talked a little bit at the full year, that we continue to do really well with better buying and range reviews and category plan optimizations. Those benefits continue and continue into the quarter, and we continue to focus on those. As Steven as mentioned in his call, though, we are getting -- obviously, logistics costs are up, both in global -- disrupted global and local supply chains. But also, as we've worked through our availability challenges, things like waste and markdowns and the like. We're doing a great job on smarter selling and delivering against our $1 billion promise that we talked about. That continues really, really well. We continue to manage the rising food inflation, balancing the 3 major stakeholders here of our consumers and customers, our shareholders and obviously, our suppliers, our supply partners. So we're not calling out anything more than what we called out at the full year, Shaun. In relation to depreciation, I think just reminding, we -- if you recall from our Strategy Day back in 2021, we actually called out depreciation in a range of $1.67 to $1.72. What we're trying to do here is, give a broader guidance in terms of where the depreciation is likely to land for this year, given timing of timing and phasing of various capital initiatives that we've updated on.

All right. And maybe if I can just ask a second question just around supply, that seems to be the key sort of challenge for suppliers, just getting supply in market. Where are you seeing, I guess, your in-stock position or case fill rates now relative to pre-COVID? And how is Coles ensuring that it is going to get its fair share of product, as supply position improves in the industry, please?

I might answer this and then hand over to Matt. I think overall, versus pre-COVID we're still not at those levels of dialog from suppliers or those levels of availability in store, but we certainly made significant progress in the last quarter, right across the country, including in WA, which was the most impacted spot, and we've seen sales volumes respond and customer metrics respond on the back of that. Clearly, it's a watching brief as to what goes on at the moment with the flooding that we're seeing. Most of the issues at the moment are related to access, which is people getting in and out of farms, in and out of factories, on and off trains, all those type of things. I think we've got 2 or 3 railway lines down, which Matt can talk to, and so most of it is a timing thing, rather than a wipeout thing. There might be 1 or 2 things that are wiped out, but it's not anything that's catastrophic and certainly not yet as big as what we saw back in Queensland and New South Wales earlier in the year. The watching brief is probably around things like berries and stone fruits. It's not quite clear yet. Obviously, it's disappointing for farmers because it looked like we were going to have a bumper crop of most things this year, particularly in Victoria. It's not quite clear how much water all the trees and everything else will take up and therefore, what the quality of the fruit will be. Certainly from the northern regions, a lot of good news around as well. So overall, what we were seeing was in vegetables, we're beginning to see prices coming down week by week. If you look at some products like -- well, asparagus, we've been selling that for $1 each, and there's going to be probably more mangoes than we've seen for a long time. So there's some good news on the horizon as well, as some watching briefs. Matt, do you just want to talk about what else we're doing to...

I think -- the ongoing focus from the teams remains high. So there's certainly a lot of effort managing the day-to-day operations. The fragility in the supply chain post COVID is still there, even though our gaps have come down, and we are improving. I think the recent floods have demonstrated that. The positive is that the impacts are shorter term. So we have the rail line go up to [indiscernible] in South Australia through the recent floods last week. That's the same point where 200 kilometers of track was knocked out for multiple weeks early in the year. Instead of this being multiple weeks, it's been a 24, 48-hour let, and the teams are able to recover that. So there is a high degree of focus on continuing to rebuild availability. It is having the required effect. But the fragility is definitely still there, within the supply chain. We need to be continuing that focus right way through peak.

Just to your final point, Sean, of how do we know we're getting our fair share. That's -- that's what we spent 95% of our meetings talking about. And obviously, we constantly monitor who's got what were. And obviously, there's a lot of lines that we stock uniquely as well in terms of our own brand, but we try to sort of triangulate a number of data points in that department.

A large number on a very regular basis.

Your next question comes from Michael Simotas with Jefferies.

Steven, you spoke about some normalization or continued normalization in local shopping trends. You've seen quite good improvement in your 3-year growth rates in this quarter and your outlook suggests that, that momentum is continuing. How do you think you're performing relative to the broader market? Because the data was suggesting that Coles was lagging the broader market for some time. Do you think during this quarter, you've managed to close the gap somewhat?

Yes. Well, I'd say a couple of things. One is we have spent the last 2 years talking about the concept of local shopping, and that local shopping was 2 things. One was what it suggests, which is people not traveling further afield or people having made a lifestyle decision to move to the coast or whatever. And the second was co-locating. by the fact that you couldn't get everything you needed in one place. And both of those things are changing. We're seeing people move back to the cities. We're seeing people get back to the offices a bit more. And as I've said all along, local shopping will unwind, it's the case of to what degree. And we're certainly seeing shopping centers improve, CBDs are improving. Probably Melbourne is the one that still needs to improve more. We've only got 4 stores in the city center there. So it's not material from our point of view. But certainly, that sort of shopping center versus neighborhood mix is improving back. Sundays are busier than ever. And so all the things that we look at, that sort of talk to local shopping, suggests that it's beginning to reverse, and that's what we expected. Obviously, we try and accelerate that as much as we can, and that's what we're doing with things like the value campaigns and flybuys. Flybuys is becoming ever more popular. The redemptions year-on-year for the full year, we're up 28% in flybuys, which is a huge increase, and it just shows that a community of customers out there are already looking at a better value. So whether it's flybuys the value campaign, improving availability, those are all playing into our favor, as well as those changes of people getting back to work in the cities. And as migration improves now, which obviously, the government is focusing on, both new migration plus reducing the 1 million people queue, that will help Coles as well, because most of those people will end up in the metropolitan areas that we serve disproportionately. So I'm pretty comfortable that what we've said for the last 2 years is playing out and that local shopping is unwinding. The other thing that some people focus on and some people don't is new space is important in the supermarket industry. And for the last few periods of time, we've been closing as many stores as we've been opening. And going forward, we've said we'll be opening net new space of 1.5% per annum, and that's what's in the pipeline. So this year, we'll open around about 10 net new stores, which again adds to sales and adds to market share. So when you add up the 2 things of local shopping unwinding and net new space, I'd expect that we'll see an improvement in our market share. Well, that we are currently seeing an improvement in our market share, as we expect, and that will be ongoing.

Okay. That's helpful. And then the second question for me is, in August, we spoke a little bit about some changing shopping behavior around the edges. Have you seen that intensify over the last few months, as at least on paper consumers look like they're under more pressure? Is there more trading down activity? Are you seeing any change in basket sizes, et cetera?

Yes. As I say, we've mostly seen things that benefit us. I've read a lot about what might be happening. But the reality is a little bit different, and the fact is, we're selling more. Transactions are significantly increased. And what we're seeing is the benefit of our range. I think I've been, again, talking about our widest range of own brand in Australia for a few years now, and that was designed for a number of reasons, one of which is, we want to be trusted value and trusted value is low prices or consistent prices every day. And we're seeing that, in those areas of pantry, frozen and so on, it's growing popularity. So these things aren't just stats that are actually real, which is we have the widest range by far of anybody in Australia of own brand products, and that's not just at the entry price point, it's at all price points, and that will be a key strength of Coles over the coming years. What we've seen in Q1 versus Q4 is, as we look through the various demographics of low to mid to high demographics. There's some very different dynamics going on, and I'll start with the mid demographics. We've seen them buying more units and their sales going up, and they're in the sort of middle -- sweet spot, so to speak. If we look for the lower demographics, what we've seen is units and sales going down. And those are the ones that are most impacted by all of the cost of living increases that we've seen to date. And I'll come back to them in a second. And then at the higher level, what we've seen is upper demographic people spending more with us, but volume down a little bit. And that, we think, is mainly down to hospitality reasons. We interviewed 8,000 people last week just to get a read on what's going on in their lines currently and how they're thinking about cost of living increases. And what was interesting is, 20% said that they were in under extreme pressure and 60% said they were concerned about cost of living increases. But 75% of them said, they were actively managing their waste -- their food waste. And that is skewed towards the lower demographic. So what we're seeing is in those areas, we're seeing lower demographics, buying less produce, meat and buying obviously more canned and frozen foods. But what people are doing is planning, as you'd expect, planning their weekly meals much better. So the combination of shopping more frequently means you waste less, but they're also making sure that they're doing soups that they're catering in bulk, so to speak. So I think in the whole scheme of things, some fairly significant changes going on, but it is different by demographic. And obviously, our job, as I've said all along, is to cater for everybody, which is we have to be great value at the entry price points, which we think we are. And obviously, we have to innovate at the other end in health, sustainability and convenience, which again, we're doing. So we're keeping -- we're trying to keep an eye on everybody. It is moving -- certainly in supermarkets, less so in Liquor, that's been more steady. But yes, there's some significant changes happening in food. And this sort of war on waste will definitely be impacting volumes in the industry, because we're up against the year last year, where people were shopping less often. The basket sizes were significant, and obviously, the waste associated with that would have been more significant as well. So that's sort of being cut back on, and that will sort of be something that probably takes a year to annualize in the in the system. But despite all of that, our volumes are increasing, which is good news. When I say increase, I mean, the trajectory is increasing, rather than necessarily year-on-year.

Your next question comes from Adrian Lemme with Citi.

Just wanted to focus on the price locked products. And you talked about, obviously, there's ongoing inflation, we know commodity costs are rising. My question is twofold. Firstly, are you losing money on some of these price locked products, where the costs are rising? And then secondly, do you think it's encouraging a permanent switch to private label in the more commodity categories, where the quality difference between branded and private label is fairly minimal. And is this, therefore, reducing the long-term value of some of these categories?

Okay. I don't think we're going to get into pricing by product or profit by product today. I think the key thing to note here is what Charlie said, which is we're trying to manage the basket and the gross profit overall, through a number of various strategic programs, whether that's sourcing or whether it's smart selling and so on. And for us, it's about balancing the mix and trying to keep everything moving along. Clearly, it's not in anyone's or certainly not in our interest to sell products at a loss. And that's not our -- certainly not our strategy. But the most important thing is that we are -- remain competitive across a basket of items and that at the entry price points in particular. I think you said price labeling, which to me means something a little bit different. And then you talked about whether it's going to things like...

It was private label. I was just wondering if people are going to be encouraged to take up the private label, because there's not -- perhaps not that much product quality difference between the branded oil and a private label, if therefore -- there's a permanent switch by some customers and it sort of reduces the long-term value of some categories. That was my question.

Yes. Well, it's fair to say that some -- we do annual -- well, we do regular reviews of categories. But we did quarterly -- well, sorry, half yearly reviews of DPP, which is the product profitability in our stores, and we think about what are the consequences of that. But it's fair to say that some categories have been reducing in value for a long period of time now, and some have been increasing in value. And part of the challenge is, how do you manage your space accordingly as categories grow and shrink, and that's what the store change program, various short store change programs are about. And then it's all about managing range by store, and at the moment, we've moved from having a very flat range and pricing profile 4 years ago, to having a busted approach to ranging today. So it's tailored ranging, but it's in clusters. And it applies to some categories, not others. Whereas over the next few years, it will be a tailored range by store. And that will not only be -- the range is tailored, but the facings are tailored as well. So you get better availability by store, but also you're better meeting the consumer needs of those stores as well. So there will always be some categories that are doing better than others. If a category deflates, then you have a look at the category and see if there's anything you do, but the more focus should go on, what are the growing categories and how do you get an unfair share of the growth categories, as some categories decline and deflate. In those deflationary categories where it becomes commoditized, if that happens, it's because they are commodities and people don't see the difference. And that's what's happened in Australia over -- the great thing about what's happening in Australia over the last 20 years, is there were a lot of commodities around 20 years ago. And a lot of the FMCG companies and ourselves have spent a huge amount of time working on innovation, so that you get the average selling price per product; because if you don't improve sustainability, quality, convenience, health, then the average selling price doesn't necessarily increase. So if you want to get sales up and profits up in the long term, you have to innovate, because there's always something going down or there's always a disruptor trying to eat your lunch or whatever. So as all these things happen, you have to think about what you're going to do to manage the basket and grow the business.

Your next question comes from Bryan Raymond with JPMorgan.

Just following on, on the drop and lock program. Just wanted to understand how much of that is incremental programs that you may have had prior to that? And is Coles having -- putting in any funding of this relative to suppliers? Just be interested in that rough mix, if possible?

Bryan, it was cutting in a little bit out -- in and out there. Would you just mind saying that again?

Apologies. Sorry, I will try again, the drop and lock program, how much of the -- how much of that program is actually incremental to what you've already had from an EDLP program perspective prior to that? Is there much incrementality, and also is there much funding by Coles in that program as well, relative to suppliers?

Yes. There's incrementality to the drop in -- both dropped and locked. There was about 1,000 prices locked and about 500 dropped during the quarter. As we've mentioned before, every year, we allocate a value budget that Coles will endeavor to deploy. And obviously, you try and deploy that with your own initiatives, that you've got stock and marketing against it, otherwise, it tends to get whittled away during the course of the year, and that's what we've tried to do this year. And then obviously, we work with suppliers as well, because a lot of them are interested in driving volume and being in the baskets as well. So it's always a combination of factors. But certainly, when we look at the external benchmarks versus our competition or versus the broader CPI index for food, which I think was last 9%. I think we're expecting something else today shortly. But the last Australia-wide CPI for food, I think, was 9%, and we're at 7%. So we are trying to manage inflation. We're very proud of the fact that we are. We don't see our job as just waving things through, I've said that before. We want to be trusted by all of those communities that we serve and somewhat high-quality fresh seafood and others want reliable entry price points. And we've got to serve everybody well to grow the business.

And Bryan, just to build on that. I think, again, I know that this is obviously not an earnings call or a profit call. But yes, the various initiatives, as I mentioned in an earlier response, the initiatives that have been successful for Coles in delivering improvements in the gross profit and gross margin, continue into this quarter as well. So the campaigns around how we -- better buying, working with our suppliers, our range reviews and category plan optimization. Those initiatives have continued and continued into this quarter and will continue going forward. So again, I think just to leverage off of Steven's comment there into -- in addition to, obviously, the investments that we have made in value.

Okay. Great. And just a follow-up on that drop and lock, it says until the end of January on most of the products I've seen. Is that across the board, and do you envision it being sort of short-term initiative or something that will then get rolled into a broader, longer-term program, once you've reached that milestone period?

Bryan, I don't think we're legally allowed to flag what our price intentions are. I'm certainly not going to do it in front of the whole world. So we'll see how it goes. We'll see how people respond. And obviously, we've constantly got to think about what's the new news and how are we going to inspire customers and get them into our stores. But you're right, it is to the end of January. I think the other thing that we've said before and probably say again is that, we do think -- we do expect currently absent any further weather -- major weather events. We do expect inflation to start moderating in the new year, as we start cycling last year. And the only thing I'd say is, that the rates of supplier -- price requests is fairly constant, but it's against the backdrop of -- there's a lot in the system that have been executed. So that will eventually annualize.

Great. And just -- that was actually my second question just around the peaking inflation. I have been hearing about quite a few lining up for the new year, once you get through Christmas for another round. Is that in your expectations, or do you think that we should be seeing a moderation in that pace of price rises coming from suppliers?

Yes. I think the danger of not talking to everyone and talking to a few is exactly that. And even an average is an average. And as I've said before, vegetables coming down to some sort of level of price as last year. Eventually, meat will moderate for those relying on energy-based products or overseas, that's likely to be different to what's going on in Australia. And absent this current wave of weather, we were expecting bumper crops, but you can still get an asparagus for $1. The mango season is going to be one of the best ever. But there are continuing headwinds around things like wheat, which is still elevated and so on. So it's different by supplier and by category. I'm sure there are suppliers who will be coming back for -- under their increase, and we'll look closely at what and why and how we can help. But I personally don't see this lasting forever. It will moderate, and I suspect it's going to be early in the new year.