After its demerger the performance of the Coles Group Ltd [ASX:COL] share price has been average, in an otherwise volatile ASX.
Here’s what it has done since it broke off from Wesfarmers Ltd [ASX:WES]:
Not particularly inspiring stuff. But what are the prospects for the Coles share price going forward?
Coles will offer a decent dividend but operates in a competitive field
Coles is not going to revolutionise the groceries/supermarket space in the immediate future — it’s not a tech stock that has massive future earnings growth potential.
Increasingly, Coles will have to compete with competitors both new and old. Aldi is starting to assert itself and Woolworths has recently opened a state-of-the-art, $215 million distribution centre which leverages automation to improve efficiency.
With projected annual savings of $45 million, the new distribution centre will quickly pay for itself.
So, Coles will have to move quickly to update its legacy distribution centres to keep pace with Woolworths.
Then there is the behemoth lurking in the background, threatening to make major inroads into Coles market share — Amazon.
In August, Amazon opened a mammoth 43,000 square metre distribution warehouse in Sydney.
The new centre will aid the supply of AmazonFresh, a same-day grocery delivery service.
As a result, it looks like Coles will be fighting on all fronts. But there is some good news.
The company is planning on making its first dividend payment in September 2019.
The company will pay 80–90% of profits to shareholders as a dividend, potentially putting the dividend in the 5% range.
While this is a decent yield, there are a range of stocks that could perform better and have a better yield.
Low debt will help Coles’ share price but expectations need to be tempered
Coles starts its new life on the ASX with a reasonably low amount of debt — $2 billion.
This was lower than market expectations of $3 billion being shifted from Wesfarmers to Coles.
According to The Sydney Morning Herald’s Stephan Bartholomeusz:
‘The combination of the debt and the stated dividend policy will discipline the group’s decision-making, particularly as Coles will have to maintain a cash conversion rate (operating cash flows to net profit plus depreciation and amortisation) at or above its recent levels of about 108 per cent to both fund its planned capital expenditures and the foreshadowed high dividend payouts.’
In essence then, expectations for the stock will need to be tempered.
It is also worth noting two things.
While making up 64% of Wesfarmers total capital employed, Coles generated only 32% of its earnings.
Additionally, Coles reported less than .5% revenue growth between 2016 and 2018.
So to sum up, the company is well-positioned to keep earnings relatively steady and has the potential for a decent dividend, but faces increasing competition and needs to upgrade its distribution centers. It has lower than expected debt, but limited recent earnings growth.
For Money Morning