Unwanted supermarket chain Coles faces uncertain future

SUPERMARKET giant Coles is about to go through a very big change. But there is one burning question that has yet to be answered.

SUPERMARKET giant Coles will be dumped by its parent company in a shock move that leaves it facing a very uncertain future without the backing of its enormous corporate parent.

The conglomerate Wesfarmers — which is Australia’s largest company in terms of revenue — announced on Friday it was done with Coles and, after getting the necessary approvals, would spin it off into a separate company.

Wesfarmers made it clear the performance potential of the huge supermarket chain was not good enough for them to continue owning it.

“Wesfarmers will measure its success over the next decade based on the returns that we generate, not the size of our portfolio,” said Wesfarmers managing director Rob Scott on Friday. “While Coles still has many opportunities to grow … its earnings can now be expected to grow at a more moderate rate.”

The Coles business — which includes 800 supermarkets, 900 bottle shops and 700 convenience stores — has recently begun to struggle. In 2017 Coles revenue fell and so did profits. Wesfarmers shares rose sharply on the news that it was dumping Coles, up 6 per cent.

DOWN, DOWN … AND OUT

Part of the problem is Australians’ insatiable taste for lower prices. The average price of goods sold at Coles, excluding fresh food and tobacco, fell by 2.2 per cent in 2017. While a lot of the pain of those price cuts is passed onto suppliers, profit is harder to come by in a time of falling prices.

Coles can’t hike prices because if it does, shoppers will go elsewhere. Aldi is continuing to open new stores across the country, while Woolworths is forecast to grow its sales four times faster than Coles.

Kaufland is also coming on strong, and of course Amazon could one day offer its Amazon Fresh business in Australia.

Coles is being spun off into a separate company.

As this happens, Costco is also expanding with three new stores planned or under construction to add to its nine existing locations. It is also building a depot that can serve 30 warehouses. “This is Costco essentially making a long-term investment into the growth of our presence in Australia,” a Costco spokesman said.

The growing band of barbarians ready to ransack the lands on which Coles stands would make anyone nervous, and you can start to see why Wesfarmers might have wanted to get out.

But they’re not giving up everything. They will retain a stake of up to 20 per cent of Coles shares, and they will also maintain what they are calling a “substantial” share of Flybuys. If Coles has to stand on its own two feet without a controlling stake FlyBuys, that could make its life even harder post demerger.

SO WHY NO BUYER?

The era since the global financial crisis has been extremely distinctive for its low interest rates and loose money. Spare cash is just sloshing around inside the global economy, bidding prices of assets up, and major deals are going down.

In this context it is curious Wesfarmers doesn’t have a buyer for Coles in mind, and isn’t offering it for sale. Instead of selling it to another company, they’re just going to spin it off, list it on the stockmarket, and grant shares in it to existing Wesfarmers stock holders.

They didn’t want the cash? It’d be a big purchase, but surely someone somewhere would like to buy a big Australian supermarket chain? No?

Coles faces an uncertain future.

“We are always open for offers on any of our businesses,” said Wesfarmers MD Mr Scott. “If this happens to flush somebody out with a very big chequebook, that’s able to overcome the regulatory issues and pay our shareholders a good premium or control then absolutely we’d like to speak to those people.”

Such an offer is obviously not yet in prospect.

Coles may not be a flashy business, and as discussed, its growth prospects are meek and mild. But worse corporate deals have gone down in recent memory. Frank Lowy just found a willing buyer for a $33 billion worth of Westfield shopping malls at a point in history where shopping malls have never looked more wobbly. Chinese buyers in particular seem excited to invest in Australia, and privateequity is, as ever, greedy for deals.

Part of the problem facing Coles is declining prices.

But none of them have stood up and said they’ll buy Coles. That silence is slightly unnerving for anyone contemplating its future.

Coles was happily welcomed into the arms of Wesfarmers in 2007, bought for $22 billion. 11 years later it is valued by one investment bank at $19.4 billion and will have to stand on its own once again.

That can be risky, and to see why you only need to look at the other half of the company once known as Coles Myer.

Myer was listed on the stock exchange as its own entity in 2009, valued at $4.10 a share. Here we are nine years later and it has lost exactly 90 per cent of its value, standing at $0.41 a share. The competitive pressures Myer faced — foreign entrants and growing online competition — are not so different from those facing Coles.

THE RAY OF SUNSHINE

It is not all doom and gloom for the future of Coles. While circumstances look dire, the research suggests that demergers can actually be helpful. In this way of looking at things, it is Wesfarmers that has been holding Coles back, not the other way around.

An review of over 20 research papers on spin-offs says they may be valuable and announcing a spin-off can lift stock prices by 3.3 per cent.

Perhaps the best example of a good spin off is when Fosters sold off its struggling wine business, which became Treasury Wine Estates. That business which sells Penfolds wines, among others, has gone absolutely gangbusters since, with the stock price rising from around $3 in 2011 to over $17 now.

Coles is gaining a new CEO and will be newly independent. Just as some people thrive and blossom after a tough breakup, it is possible that Coles will one day look back at today and say, that was when we began to get our mojo back.