Take investment bank analysts’ calls with a grain of salt

A UBS analyst’s dire Coles predictions are a reminder to always take investment bank forecasts with a grain of salt.

A customer stocks up on fresh fruit at Coles store in Sydney. (Picture: Toby Zerna)

Today’s profit reports are showing pleasing strength in the economy but also underline how investors should always be cautious when reading analyst notes from investment banks.

Case in point, UBS retail analyst Ben Gilbert who trumpeted in a note, which subsequently featured elsewhere with a front page exclusive report, that Coles was going down the gurgler.

Coles numbers were not great, with return on capital down from 11.1 per cent to nine per cent but there are clear signs of life from Coles, with second-quarter comparable food and liquor sales up 1.4 per cent compared to 0.5 per cent in the first quarter, the best result for five quarters and continuing a run of 41 straight quarters of positive growth.

So, how did Gilbert report the fact he got it wrong?

“Good result with Coles nine per cent ahead of UBS estimates.”

A newspaper would have to headline the report — we were wrong — but analysts get to say the company surprised on the upside and that is good news.

Analyst coverage of profit reports is often clouded by their own recommendations heading into results, with a buy rating almost guaranteeing a positive write up and a sell rating the opposite.

The bottom line for investors is to be aware of these biases before taking investment bank commentary at face value.

Coles has a couple of positives in the last quarter, with New Year’s Day falling in the third quarter which boosted second quarter numbers by 0.3 per cent because it is always a quiet day.

The pace of food deflation slowed from 2.3 per cent to 0.9 per cent which also helped the numbers.

But Coles boss John Durkan is fighting a good fight against a competitor in Woolworths which has thrown $1 billion or so at price cuts to gain some advantage.

The fact sales were positive shows the economy is performing well, even if Wesfarmers is enduring its well-advertised problems with its Target department stores.

Bunnings is flying in Australia, with return on capital up eight per cent to 47 per cent but its performance in the UK is, as is well known, not good.

As mentioned above, Coles’ returns fell from 11.1 per cent to below the cost of capital at nine per cent,

Department stores, thanks to Ian Bailey and his team at Kmart are up strongly to 26.2 per cent, while Mark Ward at Officeworks is continuing to perform with returns up from 13.9 to 15.7 per cent.

Chemicals were up to 28 per cent and industrials were up but still below the cost of capital at 8.3 per cent.

Alison Watkins at Coca Cole Amatil also reported strong sales growth in the second half and overall returns on equity up from 20.4 to 20.9 per cent.